DARE - Because Entrepreneurs Do

Whether you are an established company or a startup, valuation is an important tool that provides you the power to negotiate

You can probably find the very first example of a valuation exercise done in human history in Genesis-I (The Bible). Adam and Eve, the first humans, were subjected to extraneous market forces in the form of Satan, to which they succumbed.

The forbidden apple turned out to be one of the parameters on which the divine valuation process was conducted. The result? Adam & Eve Co.’s perceived value deteriorated, and in the absence of any valuation-enhancement mechanisms in place, they got thrown down from the Garden of Eden.

Extrapolate to the 21st century. Yahoo, with its declining stock prices and Microsoft’s unsolicited overtures, has been marked with $44.6 billion, a valuation that is lower than what it believes it deserves. Its self-conducted valuation puts it at something around $56 billion, an amount that Microsoft is loathe to pay. Analysts claim that $56 billion is crazy valuation even for a company like Yahoo, given its current downswing in stock prices and the bleak economic outlook for 2008. So what does Yahoo do? It uses tools that Adam & Eve Co. never possessed; tools that increase its valuation and help it justify the $56 billion that it puts itself at.

Yahoo is just one of the many millions of corporations that find themselves in the eye of the valuation storm every now and then; and it’s not just in the context of a possible merger or acquisition. Valuation is the evaluation of a company’s total market worth, and is required in many contexts ranging from M&A transactions, investment analysis and capital budgeting to financial reporting, book-keeping, and determination of tax liabilities.

DARE/what is valuation?

It is the process of determining the current worth of an asset or company. There are many techniques that can be used to determine value, some are subjective and others are objective.

In the present context, your valuation is an important weapon that provides you the power to negotiate. The negotiation can take the form of a wrangling-out of better terms in a possible strategic partnership to a better stock price in a money-making transaction with a potential buyer.

Valuation Process: an Art and a Science
Valuation is a fluid concept. The value of your company is a variable quantity that depends on many factors, such as the general economic outlook of the market and the specific sector; the objective of valuation; the nature, history and financial condition of your business; your earning and dividend paying capacity; management and strategy, market share and strategic positioning, risk/reward aspects, level of gearing (debt), etc. Corresponding to the changes brought about in any of these factors, your valuation is likely to change.

Virtually anything can be valued, ranging from tangible assets such as real estate, hardware or market instruments such as stock, options or bonds to intangible assets such as brand name, customer relations, product quality, intellectual property rights, and even goodwill. Anything that has capability of generating capital can be valued. The key to doing an efficient valuation is to identify the money-making elements of your company and get them valued.

The valuation process primarily measures three fundamental elements of your business—growth rate, cash-flow capacity and risk profile. It is a process that started off traditionally with a mere evaluation of the financial ratios of the valuee company vis-à-vis the standard industry-specific ratios. The P/E ratio (price/ earning ratio) was every valuer’s darling baby, in the sense that it was not only easy to calculate but intuitively appealing, and hence, widely used. Although the darling baby still remains, the scene has become more holistic in nature with the inclusion of several qualitative aspects in addition to the quantitative ones. The process now is, hence, part-objective and part-subjective. Objectivity is brought in by the necessity of adopting a correct valuation methodology and calculating the corresponding ratios, whereas subjectivity creeps in because of the existence of such factors in your business which are intangible but are productive anyway, that is, your intangible assets. Part of the subjectivity is also brought in by the valuer. There is no standard way of evaluating intangible assets, which is why it requires a valuer’s better judgment to value the same. Valuation is, hence, as much of an art as a science.

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