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Private Firm Valuation - The Accuracy of Transaction-Multiples

Evidence from the Eurozone

Written by Stefan Fröwis

Paper category

Master Thesis

Subject

Business Administration>Finance

Year

2019

Abstract

Master Thesis: Valuation adjustments As shown in the previous section, according to the characteristics of the company, the company has many different values. Valuation adjustments, often referred to as valuation discounts and premiums in the literature, are used to adjust one value to another, so as to reflect the different characteristics of the target company and comparable companies, and are used as a reference for valuation of the target company. 104 Valuation adjustments can be divided into two categories. Some discounts and premiums apply to the entire company, regardless of inherited rights and restrictions in specific ownership interests. Therefore, they are called entity-level adjustments, enterprise-level adjustments, or company-level adjustments. The second group refers to valuation adjustments that are directly attributable to certain shareholder characteristics, so they are called ownership-level adjustments or shareholder-level adjustments. These adjustments reflect the rights, privileges, and control over the company or the lack of these rights, privileges, and control. 3.3.1 Valuation adjustments at the entity level As mentioned earlier, there are many adjustments that apply to the entire company. Although there is not always a consensus on which valuation adjustments must be applied, some widely used discounts should be considered in any valuation. The main entity-level valuation adjustments are as follows: Small private company discounts are adjustments applied to small private companies. Since the detailed information of small private companies is usually not as good as the detailed information of large public companies, a smaller discount represents a lack of reliable information for potential investors. Lack of information will lead to higher risks, thus justifying the purchaser’s discount. 106 Key person discounts are usually applied when the relevant personnel will no longer be part of the acquired company. The impact of the loss of relevant personnel should be inherited in the company's value, because it may have a negative impact on future operations. When dealing with small companies, this person is usually (but not necessarily) the former owner. Indicators for determining whether the key person discount applies include employee loyalty to key persons, strong relationships with suppliers and/or customers, unique innovation or technical capabilities or financial strength. 107 Portfolio discounts, non-homogeneous asset discounts, or corporate group discounts are usually applicable to the diversification of the company. Investors tend to prefer "pure participants", that is, companies that only focus on one area of ​​operations or at least focus on supply chain-related industries. It is generally believed that diversified companies lack focus, resulting in a lack of performance compared to professional companies. 5.1.4 Transaction multiples The goal of this article is to evaluate the relative valuation accuracy between transaction multiples. It makes sense to compare as many multiples as possible. Ideally, a combination of equity and enterprise value multiples is used to calculate forward multiples and trailing multiples. 214 Unfortunately, when it comes to transaction multiples, the information required to generate these multiples is usually very small. In addition, having an appropriate sample size is crucial to ensure that the results are not biased and meet statistical requirements. For closed companies, there is usually no cash flow information available, which prevents the generation of statistically sufficient cash flow multiples. Equity value multiples face the same problem because there is no reliable information about equity value drivers, such as equity book value or after-tax profits. Many transactions do not include equity value figures in the database, and background information for calculating equity value is not available. Forecasted value drivers are rarely available and often unreliable because there is usually no estimate from a financial analyst. Without reliable estimates of future value drivers, forward multiples are not feasible. In order to calculate a sufficiently large sample to meet the statistical requirements of clean multiple analysis, four different trailing enterprise value multiples are used to measure valuation accuracy. Transactional Enterprise Value (DEV) represents the value of the operating business and therefore also represents the company's investment capital. It defines the company's ability to generate profits and is an indicator of business risk. This means that DEV represents the market price of a company's total capital. The main advantage of 215 DEV is its robustness to the company's capital structure. DEV is the obvious choice for this study because the generated data set does not include any information about the company's capital structure. DEV/Salesmultiple DEV/Sales multiple is the ratio of the market price of total capital to sales. This multiple is highly comparable because it is very robust to accounting policies and strategies. The calculation is quite simple, because it does not require much data cleaning. The DEV/sales multiple can also be used to evaluate troubled companies and companies with negative profits. 216 In addition, information is easy to earn income, which leads to more comparable transactions. The main disadvantage of the DEV/Sales multiple is its limited information content. It ignores the company’s ability to generate profits and shows that the profitability, profit margin, revenue growth, and net investment are the same among comparable companies. Read Less