Share Value

Business valuations are often needed for a whole variety of reasons whether it be for legal reasons in disputes, exit planning, to satisfy owners curiosity or indeed if a business is to be sold. In all cases, it’s preferable for a valuation to be undertaken independently by an experienced Valuer, who will consider the most appropriate valuation method to be used, based on the type, structure and performance of the business. For a Limited Company, it’s important to know the value of the shares, which will indicate how much the Shareholder(s) are likely to receive for their shares, depending on the reason for the valuation.

When it comes to selling a Company, it’s important to realise that there are several other factors to take into account rather just the value of the shares. The main advantage of a share valuation prior to selling will be to understand how much the business is worth ‘on paper’ before making the decision to sell. It will also enable the business owner to understand whether or not offers from potential buyers are realistic or not and will therefore, help with negotiations, as it’s important to understand how the value has been derived at. However, the Share Value may differ to the final amount to be paid on Completion of the sale, for the following reasons…

Enterprise Value

When offers are received for a business for sale, they will typically be based on the value of the shares to be purchased, which, assuming an offer for 100% of the shares, will be the equivalent to the ‘Enterprise Value’, also known as the ‘Headline Price’. The value will be based on the same principles of the share valuation exercise, usually based on the underlying performance of the business and future expectations.

A frequently used valuation method for a profitable business will be based on calculations based on ‘Earnings Before Interest, Tax, Depreciation and Amortisation’ (EBITDA), with ‘normalising adjustments’ made for one-off income or costs, in order to arrive at an ‘Adjusted EBITDA’ (sometimes known as the ‘Normalised EBITDA’) figure, with a multiplier applied, depending on type and size of business, marketplace, risk factors etc.

It is important to realise that the Enterprise Value or Headline Price is ‘free’ of the Company’s actual cash and debt positions at the time the deal is legally completed, which will, (one way or the other) ultimately affect the final amount to be paid to the Seller, known as the Equity Value.

Equity Value

Assuming that the Buyer and Seller agree on the valuation, it is important to realise that the final offer price may be different to Enterprise Value. This is because the value is based on underlying business, regardless of the actual timing of the sale transaction and the level of cash or debt within the business. For this reason, offers are often made on a ‘Cash Free, Debt Free’ (CFDF) basis.

Basically, ‘Cash Free, Debt Free‘ is a transaction where the buyer acquires a business without taking on the Seller’s debt or keeping any surplus cash.

Where debt is concerned, buyers will be reluctant to fund and service the debt which often take the forms of bank loans, overdraft, factoring etc. which may reduce the Enterprise Value. However, subject to negotiation, it can be agreed that a certain amount of debt can be taken on, such as long-term finance or invoice factoring, if the seller can persuade the buyer that the debt is intrinsic to the operations of the business.

Deals will normally be arranged for enough cash to be left within the business to provide sufficient Working Capital i.e. the money the business needs to be available to run its day to day operations. Where there is ‘Surplus Cash‘ at the time of Completion, it would only be right for the seller to be rewarded on a ‘Cash for Cash’ basis and leaving Surplus Cash within the business may also be beneficial from a Seller’s tax point of view, if the Buyer can agree to take this on.

Working Capital equals Current Assets less Current Liabilities e.g. Stock plus Trade Debtors less Trade Creditors. NB. When calculating Working Capital, when selling a business, it’s important that detailed management accounts (P&L plus Balance Sheet) are available, covering at least the last 12 months of trading.

It is worth noting that the Equity Value may not be the actual amount paid on legal Completion. Very often deals are structured over a period of time (say two to three years) to allow the Buyer to finance the deal, or maybe to ensure that the business continues to perform with the Seller’s involvement etc. Of course, a ‘cash deal’ could be negotiated where all the money is paid on Completion but then this would probably be heavily discounted against the Equity Value.

In short, Equity Value equals Enterprise Value, Plus Cash, Less Debt, Plus or Minus Average Net Working Capital Surplus or Shortfall.

Summary

When selling a business, it is especially important for the Seller to understand the likely difference between the Share Value/Enterprise Value and Equity Value, depending on how the business is trading at the time of a sale. A good recommendation is for parties to agree an example calculation based on the last set of Management Accounts (with a detailed balance sheet) as early on in the process as possible, to try and overcome any areas of disagreement. Cash Free/Debt Free deals may sound simplistic but can be anything but, once the detail has been agreed. Always best to seek professional advice – this will provide the best chance of avoiding prolonged negotiations, costs and aborted deals.

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