Valuation methodologies

A company’s value in the market today is based on a variety of factors such as: The overall economy, the product category (hot segment or a commodity), the size of the company (larger companies sell for higher multiples than smaller ones), the company’s profitability, growth rate of sales and profits, the types of customers, and other factors. Another factor that effects valuations is the level of interest of the prospective acquirer, the methods they use to determine values, and the synergy’s they would enjoy.

In many cases the acquirer will use an average of three or four factors and generate a high-low range of values. The initial offer will be the low figure and they will not want to exceed the high figure. The generally used factors are:

NB

Multiples and ratios vary depending upon the general economy, various market conditions and other factors specific to particular companies or market segments. The below information is for general guidance under normal conditions.

• Sales: In today’s market—in the food industry, companies are selling for 40% to 60% of sales (sometimes 100% or more under special circumstances of very high growth rates, emerging category, etc.). Only when you get to very large ($50 million or more) organizations do you occasionally see higher multiples.
• Gross Profits: Gross Profits are used for companies with multiple brands where it is difficult to identify sales and administrative costs with a particular brand. Gross Profits are also used for companies that are losing money. Generally a buyer will pay between a low of one and a high of four times yearly gross profit—1.0-2.5 times gross profit is a good average, particularly for smaller companies.
• Operating Profit: Valuations are frequently based on several variations of this line in the income statement.

EBITDA adds the values for depreciation and amortization to EBIT. This is a proxy for cash flow (changes in balance sheet accounts are not included).

In either case, if the owner’s compensation and “perks” are more than would be paid to a manager then — the amount of compensation above a manager’s, is added back into profit. This is known as “re-casting the income statement.” Acquirers in today’s market are paying 4 to 8 times EBITDA with the higher end of the range going to companies with rapidly growing sales, high margins or firms in high interest categories.

• Contribution: Is a line on an income statement, similar to EBIT that is used by corporations with divisions or subsidiaries that have their own income statements. It stands for profit contribution before corporate overhead, interest or taxes. For our purposes, it is similar to EBIT.
• Recent Transactions: Most companies in the middle market are privately owned and information on what they sold for is difficult to obtain. However, through our own efforts and our contacts, Tidewater has assembled a fairly extensive database of acquisitions in the middle market and information on the selling price of the transaction.
• Net Assets/Net Worth: Generally, it includes those assets and liabilities the acquirer expects to buy or assume. Multiples can run from 1 to 3 or more times the value of net assets/net worth.
• Present Value of Future Cash Flows: In this, the most sophisticated method of determining value, future earnings before interest (and sometimes taxes, depending on the method used) are projected for three to five years and “discounted” back to their present value by the use of a hurdle rate. The hurdle rate (also known as the discount rate) is the acquiring company’s weighted average cost of capital, and it varies from company to company. In today’s economy, we use hurdle rates of 10%, 12%, & 15%.

Buyers & Sellers Benefit

Past vs. Future: In today’s acquisition market, the sophisticated decision-makers in acquiring companies are looking at both the future and the past performance of a target company. In this instance, management looks at future sales and profits of the target company’s product lines — when it will be manufactured and sold by the acquiring organization. This brings into focus manufacturing and purchasing efficiencies, and the clout of the larger organizations sales force. In addition, management also looks closely at what markets and accounts will be opened for their existing products because of the acquisition.

Important valuation issues

Emerging Category: When a category within the food industry becomes “hot,” it can create additional value for the buyer and seller. This occurs, because the acquirer believes that the possibility of rapid sales growth can also produce larger than average profits over the near term. This “value added” will diminish as the category becomes mainstream and the potential for rapid sales and profit growth tends to normalize.

Organic, natural & health-oriented products, gourmet snack and certain specialty markets are experiencing above average growth rates that are expected to continue.

Acquisitions – Methods of payment: Can help both the acquirer and the seller achieve a “win-win” situation. When the seller is willing to accept a combination of cash at closing, a note payable and perhaps a royalty (with both the note and the royalty being guaranteed), the seller can frequently achieve the desired level of value for the firm. This also enables the buyer to spread acquisition payments over a longer period and thus manage the consolidated firms’ cash flow. A transaction may contain a variety of financial instruments to make up the total price. These instruments do not always occur, but sometimes do when both the buyer and the seller are trying to find a way to make the transaction successful for each party

Cash: Usually makes up 50% of the transaction, but this can vary.

Note Payable: The note is usually for 3-5 years, with interest. The note is normally guaranteed by the buyer, unless the buyer is a substantial corporation.

Royalty: A royalty does not pay interest and it is tax deductible (unlike the principal of a note payable). This is very attractive to a buyer. From the sellers prospective, in return for giving up interest and providing the tax deduction, the seller expects to get a higher total price for the company. Royalties vary in percentage and duration. Sometimes the percentage is stated, and the duration left open until a minimum agreed amount is finally paid. In many cases the amount of the royalty is also guaranteed by the buyer, although when this occurs, they frequently demand that a cap be placed on the total royalty to be paid.