Wednesday 29 June 2016

Business Valuation - K.I.S.S.

There is a misconception that many people have that the more quantitative and complex a business valuation model, the better the business valuation final conclusion will be. The reality is usually quite different, especially when analysis-paralysis sets in.  Sometimes the K.I.S.S. principle is a good one to remember.

In reality, when an arm's length buyer and seller negotiate the purchase & sale of a business they usually do not go to great pains to calculate things like foregone tax shield, unlevered betas, equity risk premiums, size premiums, and so on. A buyer and seller in the heat of a negotiation will usually focus on things like:
  • How sustainable is the cash flow of the business?\
  • How risky is the business's source of earnings?
  • How can the buyer transition the business to himself?
  • Can they grow the business?

are the truly important issues to get right.
The point of this blog post is NOT to argue for the simplification of business valuation. Quite the contrary.  Instead, it is to focus on priorities. As a chartered business valuator, my focus is on always keeping my eye on the basic principles of business valuation, which are:
  • What are the expected earnings of a business?
  • How risky do I think these earnings are?
  • What is the expected growth rate of these earnings?
These are the paramount issues to get right in a business valuation. I would much rather spend my time on understanding these fundamentals of a business, in order to get them right. If these are wrong, then no amount of tax shield calculations in the world will make the value conclusion correct.

As a Chartered Business Valuators, we are trained to focus on the principles of business valuation and to not get lost in the noise of an overly complex model.

If you need a professional, independent business valuation please contact us.

Steve Skrlac, B.A (Econ), MBA, CFA, CBV
Keystone Business Valuations

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