Home General The price of a company

The price of a company




When valuing the price of a company , it is important to know the main valuation methods. One of the main elements of the business purchase and sale contract that differentiates it from the rest of the purchase and sale of goods and that justifies its complexity is that its object is a business in operation that generates flows that causes its valuation to differ from one day to the next.

Hence, in the course of negotiations for the best trademark registration services, it is impossible for the parties to determine exactly what the valuation of the company will be at the time the transfer is executed.

The solution is, then, for the parties to establish a moment in time in which to look at the company’s financial information (for example, the latest audited financial statements) and, based on those, establish a provisional company price that will be will be adjusted and made final as soon as the parties can verify the real valuation of the company on the date on which the transfer of risk from the seller to the buyer occurs, that is, at closing (exception made to the Locked Box mechanism about which we will discuss in this section).

The valuation of the company object of the sale constitutes the starting point for determining the company price.

The price of a company, as we will see, does not have to coincide with the valuation assigned to it (and it is normal for them not to coincide) for the simple reason that company valuation methods incorporate parameters such as the expectation of future growth of the company and the additional value created by the integration of the acquired company into the buyer’s business and usually do not pay attention to the existing capital structure of the company (debt and cash).

Hence, two businesses with identical valuation, that is, with identical capacity to generate profits in the future in the eyes of the same buyer, may have, for this buyer, a different price due to a different capital structure, that is, a greater or lower net debt understood as the difference between debt and cash.

The main valuation methods used in the practice of buying and selling companies are two, the method based on the generation of cash flows and the comparative methods with the application of multiples, among which the EBITDA multiples stand out. .

Price of a company: discount method and future cash flows

The future cash flow discounting method is based on the present value rule which states that the value of any financial asset is the present value of its future cash flows. The company’s projected free cash flows (after taxes, but without taking into account debt) over a given period of years are calculated.

Then the residual value of the company is calculated (which functions as the final cash flow at the end of the period considered) and a certain discount rate is chosen that reflects the risk of the investment. The update of the sum of the free cash flows and the residual value calculated discounted by applying said rate will be the value of the company.

The EBITDA multiples method

EBITDA is the company’s profit before interest, taxes, depreciation and amortization and constitutes a good magnitude for the valuation of companies since it eliminates the concepts that can give rise to greater distortion in the results of a company, namely, the capital structure (debt), the fiscal pressure (taxes) and the accounting expenses linked to the ownership of fixed assets (depreciation and amortization).

This allows you to make fair comparisons between companies, regardless of the jurisdiction they are from.

The result of applying the valuation method does not constitute the value of the shares or, in other words, the purchase and sale price (equity value) but rather the value of the company (enterprise value).

The underlying reason is the one already advanced, that neither EBITDA nor the concept of free cash flow pay attention to the capital structure of the company (net debt), but rather focus on the capacity to generate profits or cash flows. company futures cash.

Therefore, from the above it can be inferred that:

  • The enterprise value is the value of the company assuming zero cash and zero debt (debt-free/cash-free)
  • The equity value is the enterprise value reduced by the net financial debt, this being the difference between the debt and the cash.

Once the enterprise value of the company has been reached, the buyer will look at the still photo that has been agreed upon with the buyer as a reference for calculating the provisional enterprise price (those latest audited financial statements), subtract the debt and cash recorded there (as well as other concepts of debt and cash that the buyer has detected during the Due Diligence process) and will obtain the equity value that will be satisfied to the seller at closing.

At Letslaw, we have extensive experience in the sector, our will be happy to advise you on everything you need. Ask us!


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Linda Barbara

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