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Business Valuation

How to Value Private Limited Knowledge Based Companies

Written by F. Olsson, M. Persson

Paper category

Master Thesis


Business Administration>Finance




Master Thesis: Valuation motives In today’s increasingly globalized business world, mergers, acquisitions, initial public offerings (IPOs) and raising new capital are challenges that managers face every day, and corporate valuation is more important than ever (PriceWaterHouseCoopers, 2005) ). Whether you are a potential investor, a member of the board of directors or a manager, it is always beneficial to understand and understand the value of the company and the valuation process, and in some cases it is essential. As mentioned earlier, due to different reasons, different parties have conducted assessments in many different situations (Frykman & Tolleryd, 2003). The purpose of the valuation is to determine the direction and scope of the execution of the work. For example, if the purpose of valuation is for an IPO, then it will have a broader value than the board of directors merely knowing the purpose of the listing. Understanding the purpose is also important because it defines the value to be given a specific weight and used as a valuation benchmark (PriceWaterHouseCoopers, 2005). 3.2 Due diligence According to Nationalencyklopedin (2009b), due diligence is an in-depth company investigation on the legal, financial and market orientation of a company, for example, before a merger or acquisition. Due diligence analysis is usually to provide new potential owners with their own understanding of the company, but also as a tool to control the information provided by the owner to match reality. The due diligence analysis of the two companies is almost never the same, one of the reasons is what the seller is prepared to show at this stage of the sales process (PriceWater-HouseCoopers, 2005). At the beginning of the due diligence analysis, an overview of six different areas was analyzed. The purpose of business analysis is to give the buyer a broader understanding of the company's environment. In the transaction process, it is also necessary to understand the basic knowledge of market dynamics and business risks that affect the business (Deloitte, 2009a). Financial analysis is usually an accurate review of the company's financial data, such as income and cash flow. The other analysis performed is operational analysis, which focuses on the daily functions of the company. Environmental and legal issues are also areas of concern for potential buyers (Lawrence, 1994). Not every potential buyer conducts a due diligence analysis. The analysis is only interesting at certain points in the transition process. At this point, the potential buyer has already given the reason for the acquisition and an indicative offer. 3.3 Financial analysis analysts use a wide range of models when making financial valuations of companies. It covers everything from simple models to extremely complex models. These models usually make very different assumptions, but they do share some common characteristics. Generally speaking, there are three main valuation methods. The first, the discounted cash flow model is used to view the value of assets by using the present value of future cash flows. The second relative valuation is to look at comparable variables, such as earnings, book value, sales, etc. Finally, the valuation of contingent claims uses an option pricing model to measure value (Damodaran, 2002). The last model will not be used in this article because the focus is on private limited companies, so the company’s lack of publicly traded stocks and options makes it difficult to value. The input of the value of the relevant asset cannot be found in the financial market, so assumptions that increase the error must be made. When analyzing a company’s business and its environment, the quality of the valuation is critical to the results. To perform a good analysis, you need to master the discounted cash flow (DCF) calculation, but after completion, the focus should be shifted to the internal value creation process of the company (Frykman & Tolleryd, 2003) 3.3.1 Discounted cash flow model Discounted cash flow Valuation (DCF) relates the value of an asset to the present value (PV) of the expected future cash flows of the asset and is the basis for all other valuation methods. This method is based on the present value rule, in which the value of any asset is the present value of expected future cash flows (Damoda-ran, 2002). The DCF model looks like this model provides a reliable and detailed insight into company value (Cope-land et al., 1990), and it is the most trusted and used valuation method (Weston & Weaver 2004). This method calculates the present value of all future free cash flows (FCF) generated by the company and is called discounted cash flow (DCF). By calculating FCF, it can be ensured that the generated CF can be used by capital providers of equity and capital (Copeland et al., 1990). The value of the company’s equity is equal to the present value of the net cash flow generated by the company’s assets, including the present value of future investments. The free cash flow method estimates the overall value of the company, and obtains the equity value by subtracting the market value of non-equity liabilities (Damodaran, 2002). The purpose of valuation is different, and there are differences; the entire company can be valued, or only the equity can be valued. Read Less