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Understanding the process of evaluating the economic value of companies “VALUATION”

Edson Gissoni and Rual Rousselet – Executive Partners of DMS PARTNERS

Determining the economic value of companies is a critical factor in mergers and acquisitions negotiations and aims to estimate a reference range that serves as a basis for negotiations. Buyers and sellers always fear that they are paying more than they should or asking for less than they could respectively, but in the end it is important to highlight that the value of a business will always be defined by the negotiation process between interested parties, and that the reference value of a company, calculated by evaluation processes, represent only the potential value of a business depending on the expectations of generating future results.

There are several methods for assessing the economic value of a company. These include

methods based on discounted cash flow (DCF), relative (multiple) methods,

market methods and action methods, the first two being the most used in

business buying and selling processes:

  • Discounted Cash Flow (DCF) Methods: DCF methods evaluate the economic value of a company based on the company's expected future cash flow. These future cash flows are discounted to their net present value, providing a current valuation value.

  • Relative or Multiple Methods: Relative methods evaluate the economic value of a company based on its performance relative to other similar companies. For example, the price-to-earnings (P/E) multiplier method compares a company's current stock price to its earnings-to-price (P/E) ratio for other similar companies.

  • Market methods: Market methods evaluate the economic value of a company based on the company's current share price. These share prices reflect investors' predictions about the company's future performance.

  • Stock methods: Stock methods evaluate the economic value of a company based on the number of existing shares and their current price. This methodology is used to evaluate private companies that are not listed on the stock exchange.

It is worth noting that no method provides a precise and unique value for a company, but rather an estimate of value. This is because decisions that affect revenues, costs, expenses, working capital and investments, combined with changes in the local and global economic situation, influence the company's results and change its value. Depending on the model adopted, the assumptions made and the scenarios created, two evaluators can obtain different results for the same company. In this sense, the objective of evaluating companies does not need to be to determine the exact value at which they can be traded, but rather to establish a range of values.

For the buyer, what matters is determining the maximum value that can be paid, while for the seller, what matters is determining the minimum acceptable value to negotiate. These two values will be subject to negotiation to define the final price, which will generally be at an intermediate point between the two extremes.

Assessment models are essentially quantitative, however the assessment process includes many subjective aspects, included in the premises of such models. Therefore, such assumptions must be carefully analyzed, as they are fundamental to the quality of the model and the reliability of the results. Furthermore, other important factors play a role in defining the final price of the transaction, for example, for a potential strategic investor, the “time to market”, synergies between operations, the opening of new markets, the increase in the product portfolio and/or or customers and many others, are value-adding factors.

The owner's expectations of the value of a company can be very different from the value offered by a potential investor or estimated by analysts and appraisers. The entrepreneur generally has a sentimental value for the company and tends to project high, continuous and sustained growth on it and as he normally has in his memory all the investments already made during the company's life, he tends to consider these investments as a preponderant reference of value.

For these and other reasons, the preparation of the company for sale and the assessment of its economic value, carried out by specialized independent advisors, who must be impartial, are fundamental in the process of selling or purchasing companies. The role of advisors in these types of transactions should be to evaluate the company without being optimistic or conservative, but simply realistic.

Count on the advice of DMS Partners’ team of Mergers & Acquisitions (M&A) specialists.


The Art of M&A – A Merger, Acquisition, and Buyout Guide Alexandra Reed Lajoux with Capital Expert Services, LLC – Fifth Edition

Company Valuation – A Guide to Mergers & Acquisitions and Private Equity

Roy Martelanc, Rodrigo Pasin and Fernando Pereira

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