When it comes to Company Values, half of the companies have defined values. A long-term approach since these have been determined for at least 20 years for about a third of companies.

# The definition of values: a practice more widespread than we think

For 40% of the managers surveyed, the practice of defining Company Values is not widespread. A perception somewhat out of step with reality. Indeed, 46% of respondents say they have defined it, and a half (48%) say they have defined between 3 and 5 values. Among those who defined them:

- 35% say their values are over 20 years old;
- 97% think that they always correspond to the reality of the life of the company.

The vast majority of leaders are convinced of the merits of this approach, especially in the context of communication actions. They are:

- 96% consider it a way to guide HR communication to the internal;
- 91% believe that this helps to orient HR communication to the outside world.

# How to educate employees?

In addition to communication, the managers surveyed identify another practice by which employees of the company can appropriate the values defined: workshops. However, for the vast majority of them, “acts of exemplarity” remain the most effective way to disseminate these values. The regular mention of values is part of these exemplary acts for 88% of respondents.

About promotional material, corporate communication is privileged:

- the presentation of the company for 97% of respondents;
- the completion of a welcome booklet for 94% of them;
- distribution of brochures or links to the website for 93% of them.

Other, less popular means are also used:

- public relations for 84% of respondents;
- an intranet for 83% of them;
- an annual report for 77%.

The study also shows that the **values of the company** bring a lot to the employees. The culture of the company is strengthened. They help to illuminate the actions of employees by giving meaning to work done and motivating the staff. Also, managers are inspired and refer to it to make decisions, direct and supervise employees.

# Valuation of a company: methods and price adjustment

To adequately prepare the transfer of your business, or work on an acquisition project, we must look at its valuation. Numerous valuation methods exist the asset management approach, the cash flow method, the comparative approach, the performance-based methods, the scale method …

We present in this article the primary methods of valuation of the company, the choice of the method of Company Values and the adjustment of the amount calculated according to the essential criteria.

# Different methods of business valuation

There are many valuation methods available for valuing the sale price of your business. We will present here the four primary methods:

- Heritage Assessments
- Performance-based assessments
- Evaluations based on free cash flow
- Comparative approach assessments
- Scale evaluations

Depending on your situation, it is then necessary to select one or two suitable evaluation methods, then to adjust the amounts obtained according to the criteria considered significant.

As we mentioned in our particular file on the preparation of a business transfer, the evaluation phase is essential. However, it merely provides an idea of the value of your business, and the final sale price will then be agreed upon in negotiations with the acquirer.

## Valuing your business with the heritage approach

The asset valuation method consists of separately measuring each of the assets and liabilities (debt and provisions for risks and charges) recorded in the balance sheet of the company to obtain a corrected and revalued “net asset” corresponding to the value of society.

The valuation of each item is essential since **book value of a company** do not often reflect the actual value of an asset or liability, so they should be re-evaluated. To apply the method with relevance, the correct methods of evaluation must be retained.

## Value your company about its performance

The valuation of the transfer price based on the performance of the company consists of applying a percentage or a figure to a performance indicator. For example, we can use financial indicators such as the commercial margin, the value added, the gross operating surplus, the result …

For specific activities, the valuation of the company’s transfer price can be worked out based on a critical indicator of the company’s activity.

It can, for example, be the number of subscribers for a store publisher, the number of pages viewed or the audience for a company that publishes websites, the volume of production for a company that manufactures a product or a material…

## Valuing your business with the free cash flow method

This method, also known as the DCF method, consists in estimating the market value to **know the company values** of an enterprise by adding the free cash flow after discounted taxes to the rate of return required for the investors, then subtracting the value of the net indebtedness.

## Free cash flow is calculated as follows:

Free cash flow = Gross operating surplus – Notional corporation tax on operating profit – Change in working capital requirement – Investments net of divestments.

This valuation method is based on the company’s future performance over several years, the cash flows are calculated on forecast data, and therefore assumptions. As a precaution, several scenarios must be planned. The choice of duration and discount rate is a decisive and challenging task for the evaluation of the company.

The free cash flow method of company valuation has the advantage of being based on the future of the business rather than its past, and its future profitability rather than its heritage values. In return, the application of this method is susceptible to the assumptions made. Forecasts must be made over a relatively extended period to make the calculations.

It is preferable to be accompanied by a chartered accountant or by a specialist of the transfer of company in case of recourse to this complicated technique.

## How to Value a Company with the comparative approach

The comparative approach consists of valuing one’s business relative to a sample of comparable companies that must have the same sectoral, geographical and operating characteristics. It is also possible to rely on recent disposals of comparable companies.

To determine a valuation, you must find several companies similar to yours as well as their transfer price or their value (when they have not been sold). Your price must then be adjusted according to several criteria considered significant concerning your activity. The advantage of this method is to offer a transfer price consistent with the current market.

However, the application of this method is impossible in the absence of comparable companies nearby.

## Value your business based on price lists

Small businesses are often evaluated on the scale as a percentage of turnover, which is used by experts and courts. This method provides a valuation of the sale price that does not take into account inventory.

One must be careful with this approach because it does not reflect the profitability of the business, does not take into account the location of the company, its reputation, the state of its production tool and premises …

The scaling approach provides an idea of the average transfer price of companies in the same sector.

## Adjustment of the valuation according to the criteria of importance

Then, the first evaluations carried out with the methods you have selected must be adjusted taking into account several important criteria. These essential criteria combine both general criteria and criteria that depend on the activity you perform.

**Here are some examples of general criteria:
**

- ongoing litigation may reduce valuation,
- a loyal and diversified clientele can increase the valuation,
- the importance of the manager’s relationship with the business may reduce valuation,

Here are some examples of criteria related to the activity:

- for production companies: the state of the production tool and the possible elements to be replaced,
- for convenience stores: the state and location of the premises.

## How to choose among all these valuation methods?

Each of the methods presented above has its advantages and disadvantages, so you need to identify the ones that are best for you. For this, we advise you to take stock with your accountant or with a professional transfer company.

In practice, for TPE / SME transmissions, the comparative approach and the scale evaluation are generally used to evaluate a transfer price. Then, some methods are recommended by sector of activity, so we must learn about it.

In any case, we advise you to use comparative evaluation as one of your selected methods, to be consistent with the current market. Potential buyers who are looking for a target will compare several similar businesses for sale before making their choice (similar to the real estate market). A transfer price higher than the average market price reduces your chances of finding interested buyers.

The results obtained from the valuation of your company remain theoretical, the actual price of sale will be determined according to the opportunities available to you and the negotiations that you will lead with the buyers.

# What Are the Valuation Techniques of a Company?

An essential step in the Mergers & Acquisitions process, the valuation of a company, is a complex operation because of the plurality of elements that come into play. The valuation of a company goes beyond the pure financial considerations represented by its balance sheets and profit and loss accounts. Estimated accounts, the potential of the market, the profile of the team, the development phase of the company, the obstacles to development, the barriers to market entry, the key factors of success, are all factors more important. Both quantitative and qualitative, which have a significant influence on the final valuation of the company.

We can speak of a multiplicity of valuation techniques since two companies with a very similar profile will never benefit from the same valuation. However, professionals use a certain number of methods and models which will be found more or less predominant in any business valuation. Thus, the difficulties in the valuation problem of companies lie less in the application of the method, but the choice of this method insofar as each method is adapted to a particular corporate profile.

# Objectives of Valuation

To value a company is to calculate the financial value of a company taking into account the past accounting data and the development potential of the company. However, the purpose of the valuation is rarely the same, and therefore the technique retained too. One distinguishes, in fact, the valuation “patrimonial” sponsored by the head of enterprise to evaluate its assets at a time T, the valuation of a target for a merger-acquisition transaction; or the valuation of a start-up in the seed phase by an investor with a view to an acquisition of shares, the valuation of a company during a “pre-IPO” round of will primarily rely on the value creation potential of the company.

Despite this plurality of objectives, a constant emerges. Whatever the development phase, the sector, the growth potential of the company, the valuation must make it possible to evaluate financially the amount that a natural or legal person should pay to acquire 100% of the company’s capital. After having realised the valuation of 100% of the capital, we will adjust the price according to the objective and the terms (acquisition of a block of securities offering a blocking minority, the sale of shares representing the majority of the voting rights, …).

In fact, two main approaches evaluate a society. Each approach is more or less used by professionals and more or less influential on the final valuation depending on the sector and the size of the company. We distinguish the actuarial approach that will value the company from its ability to generate income streams in the medium term (cash flows, dividends, …). There is also the comparative approach that values a company from data on companies with a comparable profile (comparable transactions, benchmarks, competitors’ financial data, etc.).

After presenting each of these approaches, we will present more explicitly the techniques used.

# The Actuarial Approach

The valuation of a company using an actuarial approach is based on an estimate of future income streams generated by a company, taking into account the risk of the economic asset. In other words, future cash flows will be discounted at a rate, called the discount rate, which reflects the risk of the business. The philosophy of this approach is based on the idea that the acquirer does not buy the past flows of the business, but on the contrary, the future flows (i.e. not the past wealth but the future wealth ).

However, in reality, the flows used to value a company can vary from one stakeholder to another. For some, it will be the future profits of the company, for others the future “cash-flows” or the dividends paid. In reality, the player in charge of valuation will choose the flows that seem to him the most reflect the wealth generated by a company. This choice will be made according to the profile of the company. For example, dividends for a mature industrial company and “cash flows” for an innovative company in a growth phase are more often retained, the latter reflecting the reinvestment possibilities of the company in its actions that will create greater long-term value.

We will present here the 3 most famous actuarial approach methods. The Gordon-Shapiro method, the Bates model and finally the method of discounting the “free cash flows” which is currently the most used.

# Gordon Shapiro Model

Developed in 1956, it is based on the dividend discount model. This model is based on the following principle: the price of a share is the sum of future dividend flows generated by the company, discounted at the rate of return required by the shareholders.

Gordon and Shapiro use this model but introduce a certain number of hypotheses that make it possible to value action and therefore a society:

- Dividends rise at a constant rate g, year after year (assumption of perpetual profit growth)
- The payout ratio is identical every year
- The dividend distribution period is infinite.

As a result, the formula for discounting dividends to obtain a valuation of the company is as follows:

*V = D / (r – g)*

*With:*

*• V = valuation*

*• D = dividend of the selected year (generally the last fiscal year)*

*• r = rate of return required by the shareholders*

*• g = profit growth rate*

In fact, if this formula is well known, it is little used by professionals because of the simplistic assumptions introduced. First, to be applicable, it assumes that the rate of return required by shareholders is higher than the rate of growth of dividends (r> g), which is not necessarily the case in reality. Moreover, in a constantly changing economic environment, the dividend per share varies regularly (dilutive effect of a capital increase for example), and the payout ratio is also rarely identical (after a sustainable growth phase, a company distributes generally more dividends than after a year of economic slowdown). These assumptions mean that the Gordon-Shapiro model is little used.

# The Bates Model

The Bates model is also an actuarial valuation approach for companies. It extends in a sense, the Gordon-Shapiro model, but presents a more realistic aspect insofar as it annihilates some reductive hypotheses of this model.

Bates’s model allows a company to be valued by taking into account future earnings and the payout ratio and not just the dividend as in the Gordon-Shapiro model. It also makes it possible to divide the total period of observation into sub-periods, thus annihilating the data constancy problem inherent in the Gordon-Shapiro model. Bates’ method thus benefits from a more realistic aspect since it is possible – in accordance with the reality of the market – to modify the parameters of the formula.

Also, all the strength and the room for maneuver that the transferor may have at this decisive stage of the negotiations will result from his ability to transmit the information to the purchaser progressively. It is almost impossible for the buyer to sign an irrevocable undertaking before he has been able to access specific information. On the other hand, if the quality of the information transmitted improves gradually, the trust will be established between the two parties and the purchaser will agree earlier to sign a firm commitment even if he is not yet aware of the latest vital information.

The originality and reality of Bates’ formula reside in the similar logic of the model. The relationship is as follows: the company belongs to a reference sector or sample whose data (Price Earnings Ratio, Pay-out, profit growth rate over n years and profitability required by the shareholders) are known. They make it possible to define the Price Earnings ratio of the sector to the year n. Beyond year n, the horizon is too distant, and Bates says that the sector PER is then merged with the PER of the company (PERn sector = PERn company). Therefore, based on forecasts made by analysts on the sector for periods 1 to n, it is possible to determine the current valuation of the company.

**The simplified formula is as follows:
**PER company = (PERn + [(pay-out year in progress / 0.1) B]) / A

A and B are calculation parameters (given immediately by reading the Bates table) as a function of the profit growth rate over the period considered, the rate of return required by the shareholders and the duration n of the period.

*We then obtain the valuation V = (company PER) x (profit year in progress)*

It’s ease of use and its assumptions close to making this model a valuation method commonly used by professionals. It is mainly used in the IPO of companies in the secondary market and the free market, which generally has profiles well suited to the use of this model (long enough existence, large SME often in the mature phase).

# The Method of Discounting Free Cash Flows or DCF Method

In this method, the company is considered as an entity whose value does not depend on its profit but on its profitability, which is measured by its “free cash flow” or free cash flow.

This method is an excellent complement to the method of discounting profits (which can be handled by the entrepreneur). It is used in particular for the valuation of innovative companies, which are often in a deficit position in the first years of existence and for which the discounting of profits is therefore meaningless. Moreover, we now consider that cash flows represent more realistically the value creation potential of the company because these flows can be reinjected into society.

Finally, once the two parties reach an agreement on the assignment, the last point against which the assignor will have to protect himself is the payment of the transfer price. Indeed, in practice, the price is usually paid in several instalments over several months or years by the purchaser. To prevent any risk (the buyer’s suspension of payment in the medium term, questioning of the transaction, etc.), the seller has an interest in securing payment by the buyer. This guarantee may, for example, be granted by the reference shareholder of the acquirer or a bank. The transferor can then immediately call the guarantee in case of default of future payments. Such a guarantee is common in M & A transactions.

This method is particularly suited to the majority shareholder who can measure the future financial performance of the company. By this method, the value of the enterprise is equal to the discounted sum of future flows generated by the current operation of the enterprise. In other words, this method makes it possible to identify the economic value of the firm by disregarding its financial debts, that is, its financial structure.

3 elements are important as to the relevance of this method: the initial cash-flow, the cost of capital and the long-term cash flow of the company. By discounting the cash flows at a rate at least equal to the cost of capital, the additional profit generated by the company and therefore its increase in value are evaluated.

The cash flow used is the “free cash flow”, i.e. the net cash surplus after the financing of operating and distribution investments (dividends). In other words, it is the surplus generated by the enterprise that would be made available to creditors and shareholders.

The mathematical valuation formula for free cash flows is as follows:

*V = Σ FCF a * (1 + t) ~ ª + FCF n * (1 + t) ~ ⁿ*

*• FCF a = Free cash flow of the year a*

*• t = discount rate (weighted average cost of capital)*

*• FCF n = Free cash flow of year n (last year of the period considered)*

There are several ways to calculate Free Cash-Flows from the company’s forecast data.

From the TPFF of the company, we have:

*FCF = DAFIC – (Operating Income * Tx Corporate Tax).*

*From the net result, we have FCF =Net Res *

*+ Depreciation and Provisions *

*+/- Exceptional items *

*– Change in WCR *

*– Dividends distributed *

*– Operating investments.*

Finally, to calculate the FCF n, we proceed according to a traditional approach of capitalisation and discounting flows. We will pause the assumption of the infinite growth rate of FCF, and then we have:

FCF n = FCF / (t – g)

With g = Infinite growth rate of free cash-flows.

**It is therefore easy to calculate the valuation of the company.**

The main advantage of this method is its simplicity since the FCF are easily calculated from the company’s forecast data. However, given the importance of the cash flow evaluation of yearning (which counts as half of the final valuation), we cannot use this formula from overly long-term forecasts. (FCF evaluation n would not be relevant and would distort valuation).

This method is well suited for innovative companies with good medium-term forecasts. That is why it was widely used in the evaluation of companies introduced to the French New Market between 1998 and 2000.

# The Comparative Approach

As we have seen, the actuarial approach is based on complex forecasts which are the basis of the final valuation of the company. Also, assumptions that are sometimes too restrictive, notably the assumption of stable growth of the company over a long period, limit the quality of the valuation by these methods. For example, investment bankers and financial analysts make little use of these methods, especially those based on the discounting of dividends that do not reflect the value creation of the company. However, they should not be rejected because a method that of discounting free cash flows is used almost systematically to value companies.

However, it is clear that the DCF method is by no means exhaustive. It is systematically supplemented by comparative methods that make it possible to assess the company taking into account its sector and its competitors.

The comparative approach is based on the following elements to value a company:

- Comparable transactions, i.e. on which valuation and multiples of similar companies were sold.
- Companies with a similar profile regarding size, markets, risks, …
- Reference indices such as the CAC 40, The New Market, IT.CAC, which we will use if we consider that the company is representative of this index
- A business sector if we consider that the company has characteristics representative of a sector.

The analysis and data of the sector will then be used to evaluate the society. The approach by comparable companies or the peer group.

In reality, the logic of these approaches is always the same. It consists of comparing some similar companies (the “peer group”) or a specific sector of activity to highlight some valuation multiples and ratios that will help establish a fair valuation of the company. From the data of the “peer group”, the professionals will establish the average of certain ratios (PER, PSR, …) which will make it possible to evaluate the company. The comparative approach is easier to use for listed companies because of the clear transparency of the information. However, it is also widely used for unlisted companies as it is now quite easy to obtain financial information about its competitors.

If it is widely used today, it is because the comparative approach is quite responsive to the market. It reflects more a market price than the **book value of the company**. Unlike the actuarial approach, the elements of the methods used are not fixed. It makes it possible to define at a time t, the price that an acquirer is willing to pay to acquire a company operating in a particular sector.

In other words, it gives the market price of a company at a given moment. The advantage is to obtain a valuation close to reality that takes into account market conditions, and the disadvantage is to obtain a valuation that can evolve considerably from one period to another (for example, the large gap between valuations before April 2000 and those after the Krach)

The difficulty of this method lies in the research and the use of similar criteria from sampling. It is important to consider an identical period, very close companies, at the risk of obtaining a completely distorted valuation. To obtain a good valuation and take into account the majority of the accounting elements of the “peer group”, professionals use many ratios and valuation indices that we present now.

## The Price Earnings Ratio (PER)

This is probably the most used ratio. It corresponds to the price-earnings ratio of a company. It can be expressed in two ways. Either it is equal to the ratio between the price of a share and the net profit per share, or it is equal to the valuation (market capitalisation for a listed company) of the total net profit.

Generally, it is said that the lower a PER, the cheaper the business. In fact, the obtained PER must be compared to the sectorial PER. This ratio is, in fact, similar to the payback period of the investment since it indicates the number of years of profit that will recover the initial investment.

Take the example of a company whose stock price is 150 on the financial markets and a profit per share of 10. This company has a PER of 15 (150/10) and is said to capitalise 15 times its profits. In other words, if today an investor buys a stock of this company, it will take 15 years in a constant situation to recover its initial investment of 150. The PER allows judging the market price of a security.

We understand its interest in a valuation perspective. By establishing an average sector P / E or the average P / E of a peer group, it is easy to obtain a valuation of the company by multiplying the company’s profit to be valued by the average PER.

However, although its simplicity of elaboration favors its frequency of use, this index can not claim to provide a fair valuation of a company. Exhaustive use of this index as an investment criterion would be to consider that the profit remains constant over time, which is an absurdity in an ever-changing economic environment. The PER varies in fact from one year to the next. On the other hand, its simplicity gives it a certain efficiency by allowing it to compare companies with similar profiles quickly. It thus occupies an important place in the evaluation procedure of companies.

## The dividend capitalisation ratio

This ratio is similar to the PER but takes into account the dividend paid and not the profit. Therefore, it is mostly used by investors who want to measure their return on investment. In fact, the PER takes profit into account, when in fact it is never fully paid to the shareholders. The capitalisation-to-dividend ratio is thus more specifically adapted to so-called “yield values”, by measuring, unlike the PER, the true payback period, the real income that the shareholder will receive.

This ratio is similar to the PER but takes into account the dividend paid and not the profit. Therefore, it is mostly used by investors who want to measure their return on investment. In fact, the PER takes profit into account, when in fact it is never fully paid to the shareholders. The capitalisation-to-dividend ratio is thus more specifically adapted to so-called “yield values”, by measuring, unlike the PER, the true payback period, the real income that the shareholder will receive.

However, it is sometimes used, in addition to other ratios, to compare and value companies.

The Price to Book Ratio (PBR)

It corresponds to the capitalisation ratio on Net Asset Accounting (NCA) or shares price per share. There are two possibilities to calculate the ANC:

• Net Assets = Accounting Assets – Fictitious Assets – Debts.

• Net Assets = Equity – Fictitious assets.

If this ratio capitalisation / ANC is less than 1 (which is quite rare), it is commonly accepted that the company is under-rated since this amount to saying that the company is worth less than its **book value of a company**. Similarly, in a comparative approach, we will calculate the average PBR of the “peer group” before valuing a company.

**The Price to Sales Ratio (PSR)**

This ratio corresponds to the capitalisation/turnover ratio. It allows measuring how many times the turnover is integrated into the final valuation of the company that is to say to evaluate the company from a multiple of its sales.

*This ratio and its current use make it possible to establish a standard.
*

This ratio is also often used since turnover is considered more reliable and consistent than profit. The latter, unlike the business figure that is a raw data, can be modified and improved by business leaders following accounting choices. This is commonly known since the Enron scandal, “creative accounting”. This is why, in the years to come, this ratio will be used even more often by M & A professionals. However, one disadvantage inherent to this ratio is that, according to its philosophy, two same companies regarding activity and turnover are supposed to have the same valuation.

To solve this problem, some add to the capitalisation, the net debt of the company. We then have the ratio: (capitalisation + net debt) / turnover, which allows us to take into account the company’s debt in the final valuation. Mathematically, a company will be less valued if it is indebted and vice versa.

## Other ratios

There are some ratios used by investors and financial professionals to refine the final valuations of companies. The principle is always the same: from a “peer group”, analysts derive average ratios that make it possible to evaluate a company comparable to the “peer group”. These most common ratios are:

• Capitalization ratio of cash flows (P / MBA or P / CF)

• The capitalisation ratio of EBE (does not include depreciation). It is generally noted as P / EBITDA (Anglo-Saxon concept).

• Capitalization ratio on operating income (P / Rex)

In conclusion, the comparative approach by the “peer group” is rather difficult to implement. It will be necessary to choose his sample and carry out a thorough analysis. Therefore, its application is difficult for unlisted SMEs, as it is more difficult to obtain extensive financial information on comparable companies. On the other hand, it is widely used for IPO procedures, since it will be quite easy to find a “peer group” in the financial markets. In any case, the relevance of the valuation will depend on the quality of the criteria selected.

## Other approaches

The other approaches are based on a principle comparable to the “peer group” that is to say that we will use indices, transactions, and other financial data to average some ratios and evaluate the society.

The other comparative approaches are the sectoral approach, the transactional reference approach, and the indexing approach. We will briefly present the transactional reference approach which is the most common, the other two approaches being difficult to apply as a company never perfectly reflects a sector, much less an index.

The transactional reference approach consists of measuring and comparing with financial ratios of the company to be valued the financial data of similar companies that have recently been reconciled. From the average ratios, we will value the company and then apply a discount or a rating to take into account his profile. For example, if a company has significant gearing (net debt/equity), the final valuation will be lower than the initial one. Conversely, if a company enjoys excellent visibility on its order book, a relevant business model or good development potential, we will apply one on a side compared to the initial valuation.

This technique of valorisation by transactional references is widespread because of its simplicity of application. However, it will be necessary to take into account the specificities of the company to be evaluated to reach a relative valuation. Indeed, in addition to taking into account companies and similar criteria to establish transactional references, the adjustment according to criteria specific to the company is the condition to the fair valuation of the company. Because even if we rely on comparable companies, no company (no operation) is identical economically, socially and financially speaking. For example,

Ultimately, the valuation of a society is delicate alchemy in which fixed ingredients intervene, but also variable criteria and therefore creativity. Only a guideline for valuation methods can be defined but in no way exhaustive. Professionals proceed on a case-by-case basis, customising the criteria and assumptions used based on the specificities of the company to be evaluated.

The difficulty of these operations, therefore, lies less in the application of a method than in the choice of hypotheses and in the choice of the method itself.

This is why the final valuation systematically reflects the economic reality and not the economic value of the company. The valuation of a company takes into account a plurality of criteria that will influence more or less substantially the final valuation, but which will never reflect the **book value of the company **or** Company value**.

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