A seemingly salacious title to a blog post, but the Business Valuation industry originated from alcohol – or lack thereof.In 1920 with the enactment of prohibition many enterprises that were engaged in the alcoholic beverage business were allowed tax breaks by the U.S. Government for “damages” suffered. In order to determine certain tax benefits to these businesses their “intangible value” or “goodwill” had to be determined. Prior to this time it was commonly believed that the value in a business was essentially the value of its assets less its liabilities.But, as we know today, business value comes in many forms – although most notably in the cash and profits it generates, has generated, and will generate. But goodwill is also imputed into a brand name, some special technology that may or may not have materialized into a market, and in a myriad of other ways. Even a stable staff generates goodwill.As a direct result of prohibition the IRS published a document called the Appeals and Revenue Memorandum (or ARM) 34. ARM 34 presented two novel ideas: 1) Goodwill exists if a business has earnings in excess of another “like business” and 2) Goodwill value is determined by calculating the “current value” of those excess earnings. These concepts formed the basis for the practice of business valuation today. Additional questions, responses, and new sophisticated methods dealing with business valuation resulted. Check us out over at Fair Market Valuations to find out more.Posted by: John Klearman, Fair Market Valuations
Not all buyers are created equal. We could debate about the types of business buyers out there but, excluding individuals, lets distill buyers into three categories – financial buyers, strategic or synergistic buyers, and buyers with some DNA of both previously mentioned (or hybrid buyers). In the merger and acquisition (M&A) world we frequently refer to a private equity group (PEG) as a financial buyer. Why? Well, PEGs are formed to pool resources from investors that may have an interest in “sector” investing. Look at a private equity group website like Huron Capital and you’ll see terms that resemble investor terms – minimum EBITDA, Sectors Invested, etc. A PEG may also be a synergistic investor depending upon what types of investments are in its portfolio. A synergistic buyer, by contrast, may consider acquiring a company because it adds synergy to its existing business. Consider Google’s acquisition of DoubleClick for $3.1B. In order for the buyer to justify the acquisition there must be synergy. Is a financial buyer better than a synergistic buyer or is a synergistic buyer better than a financial buyer?
There is no way to answer this because beauty is ultimately in the eye of the beholder. But, to the extent one is selling into a firm with great synergy (whether a hybrid PEG or pure strategic acquirer) the value of the selling firm is likely to incrementally increase. The simple reason for this is that highly synergistic buyers contemplate future discretionary cash flow of the selling business in their valuation decision. You’ll recall from a recent post that I mentioned that valuation efforts are about analysis, but investment banking is about advocacy. As a valuation analyst we only contemplate the notion that there is a willing buyer and a willing seller. We blend into the mix the notion of “valuing” future cash flow to determine one element of value. But ultimately the market will “make the decision” as to the value of the enterprise being sold. The purpose of a valuation in M&A, though, is to provide a benchmark, just like a real estate appraisal for a VA loan (for a trusted source, check out valoanrates.com). The purpose of M&A representation is to drive that number up.
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