This blog briefly discusses some of the most commonly used approaches and methods for the valuation of Irish companies. Valuations are subjective and can differ between practitioners and approach used. A valuation is generally a best estimate of the market price a purchaser would pay for a company. The value of a public company can, at least in theory, be calculated by using the company’s market capitalisation. It is much more difficult to value a smaller private company which has no open marketplace for the purchase of its shares. Valuations of a smaller private companies is said to be an “art not a science” and two different valuers are likely to place two different values on a private company. However, while valuers will differ in opinions there are generally accepted common approaches and methods. An approach is a theoretical framework in which a valuation is advanced a method is the way or process in which the valuation is executed. The three most common approaches to valuation are:

1. The Market approach
2. The Income approach
3. The cost approach

  The approaches are briefly explained below along with common methods for calculating the valuation.  

Market Approach

This approach seeks to value an asset by reference to a similar asset for which price information is available. This approach is useful for a type of asset where the asset has been recently sold; the asset or similar assets are publicly traded or there are frequent transactions for similar assets and for which price information is available.  The most common method of valuation used in the market approach is the comparable transactions method or Guideline Publicly Traded Comparable method whereby an indication of the value of the subject asset is arrived at by reference to market information, usually on relationships between profit measures (such as Earnings Before Interest, Tax, Depreciation and Amortisation, or “EBITDA”) and market value. So for example it might be appropriate to value a company at a 5XEBITDA multiple if a similar company sold for this multiple. Equally such a multiple might be appropriate if a similar company was quoted on the stock exchange and traded at a 5X EBITDA to Enterprise Value multiple. As implied from the above description this approach is useful for where there is public information available for a similar asset – however in practice for smaller Irish companies such information is not always available.   

The Cost Approach

The cost approach provides an indication of value using the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk, or other factors are involved. In practice the cost method sometimes used in a business valuations context is “net assets”; this would capture the value of a business where the value is best represented by the sum of its individual assets and liabilities – e.g. if the business is an investment or holding business.

Income Approach

The income approach converts future cash flows into a single valuation. The most commonly used method to calculate such a valuation is the discounted cash flow method (“DCF”) which involves discounting future cash flows back to a present value and about which there is a  more detailed CooneyCarey blog post. The income approach and DCF method is common in business valuations and is useful where there are few if any market comparable but it has limitations – discounting and future cashflows are heavily based upon assumptions and small changes in assumptions can sometimes have big impacts on valuations. 

Conclusion

As can be seen from the above descriptions no approach or method is foolproof; valuations are subjective and sensitive to assumptions. Valuation is very much an art and not a science – ultimately the professional judgement of an experienced practioner is key in arriving at a reasonable conclusion.