1. Analysis of the occasion of valuation
If a company is to undergo valuation, the occasion requiring valuation must be examined. This allows us to understand the implications of the valuation process and helps us determine the proper valuation methodology to use. For example, certain fiscal provisions require a specific type of valuation set out by law. The case is often similar when dealing with corporate contractual clauses. Only after the occasion of valuation has been analysed can the process proceed.
2. Internal corporate analysis
Provided no special provisions are in place, e.g., based in fiscal or company law, companies are valuated using economic methods. To do this, the company’s baseline must first be analysed.
Analyses of annual financial statements, current accounting and a company overview provide the initial basis for the focus of the analysis. The quality of accounting is assessed as part of the analysis of the annual financial statements. A decision must also be taken as to how many past years are to be included in the analysis. This can vary widely on a case by case basis. The results of the corporate analysis should also indicate the long-term profitability of the company. To do this, adjustments are made for past special effects. If, for example, aperiodic, non-recurrent positive and negative events were recorded in the annual financial statements, these must be settled and the adjusted annual financial statements resubmitted for analysis.
3. External corporate analysis
In addition to analysing the annual financial statements, the company and its market position must be analysed. This first and foremost includes the analysis of competition and intensity of competition. This kind of analysis is generally performed using a Porter’s five forces analysis. The company and its products and services also undergo a life-cycle analysis and a potential analysis. Both analysis results are then subjected to a global trend analysis. This process, which is structured as a PESTEL analysis, includes political, economic, socio-cultural, technological, legal and fiscal aspects.
With respect to these environmental analyses, a connection to the company is established comprising strengths, weaknesses, opportunities and risks as part of a SWOT analysis. The SWOT analysis compares the company’s external situation with its internal situation. This is a strategic management tool.
4. Integrated corporate planning
Based on this analysis of the company's situation and its past, either a corporate plan is created or a business plan developed by the company is tested for plausibility.
This corporate planning is based on the business knowledge that corporate values are derived from future potential for success, not from past performance. As Eugen Schmalenbach once said, “The mill cannot grind with the water that is past.” So the analysis of the past and the assessment of the current situation only form the basis for corporate planning.
As an integrated budgetary forecast, corporate planning not only includes earnings prospects, but also the development of the balance sheet and liquidity. The planning period only extends until the company has achieved a so-called steady state. This means that the last year included in the plan will result in a state of equilibrium that permits any future changes to be balanced.
In practice, these planning periods span three to ten years. In exceptional cases, e.g., companies in crisis situations or high-growth companies, this period may also be shorter or longer.
5. Determining the expected value of future earnings or cash flows
Virtually without exception, corporate valuation serves to aid the decision-making process. The sale or acquisition of a company could be made dependent on this, or its taxation, for example. However, if the purpose of the company valuation is to aid in the decision-making process, the corporate planning must be appropriate for that decision.
There is a consensus in business administration that only the so-called expected value can be considered a suitable criterion for decision-making. The expected value summarises all the opportunities and risks of future development. In this case, the decision value may deviate from the management approach. If the company has submitted a plan based on the management approach, whether and to what extent this approach differs from the expected value must be reviewed and, where applicable, corrections must be made to the plan with respect to the occasion for valuation.
One manifestation of this expected value is the adjustment of future income and cash flows to transferable profitability when evaluating SMEs in the event of a change of ownership. Business relationships in SMEs are often highly personal and cannot or can only to a limited extent to be passed on to the transferee. In these cases, this "loss" must be considered in the budgetary planning.
6. Determining the valuation method
Only once this corporate planning budget has been completed and validated is the evaluator able to determine what method or company valuation or evaluation method is best suited. A company may find itself in any number of different situations in which certain valuation methods are prescribed or prohibited. This assessment can only be made on the basis of corporate planning.
Once the method has been selected, further steps can be taken in the company valuation process.
7. German income approach
If the company is being evaluated using the conventional income approach used in Germany, the first thing that must be determined from the corporate planning is what income can be distributed. We must first examine which profits are distributable according to the criteria prescribed under commercial law.
We then review whether this kind of distribution is economically justifiable. The profit distributions permitted under commercial law that are economically justifiable make up the quantity of capitalisation for the company valuation under the German income approach. The fiscal implications must then be taken into account and the discount rate determined. The CAPM (capital asset pricing model) or tax-CAPM (tax capital asset pricing model) are typically applied. The value determined using these models is then reviewed for plausibility.
8. DCF (discounted cash flow) method
If the company is valued using the discounted cash flow method, a decision must first be taken as to whether a gross method (total cash flow as WACC or APV) or a net method (flow to equity) will be applied as a subset of the DCF method. With the gross method, cash flows are analysed before interest, amortisation and capital changes, whilst the flow to equity method (net method) only discounts the cash flows accrued by the owners.
As a result of this variety of methods, either weighted capital costs are applied, or else the capital costs of the hypothetically unindebted company and then the debt burden are deducted when using the gross method. By contrast, the net method uses equity costs and therefore directly concludes the company value (equity value).
9. Liquidation value
In any assessment procedure, it is commonly agreed that the lower value limit always represents the liquidation value. The liquidation value also comes into play if this is higher than the continuation value when using the German income approach or the DCF method. For the liquidation value, a liquidation is planned and the cash flows from the liquidation, including all revenues and expenditures and all the financial implications of liquidation on the date of valuation are taken into account on a discounted basis.
In the valuation practice, e.g., investment banking or M&A consultancy, multipliers are regularly used as part of the company valuation process. In traditional business administration, multipliers only serve to review the valuation results obtained fundamentally, i.e. the company valuation from the planned future earnings or cash flows.
In practice, there are several data providers. These data providers maintain databases that record corporate acquisitions and sales. Multipliers can be determined using the transaction data contained therein. The best known multipliers are the price-earnings ratio and EBIT multipliers.
In reality, however, any figure can be used to form a multiplier. For example, telecommunications companies can be evaluated based on the number of customers and accounting firms based on sales figures.
We only use multipliers to verify the results of our valuations or for an “indicative company valuation” if there is very little time to perform the valuation.
11. Net asset value
The idea behind the net asset value method is for the company to be recreated on a clean slate. This means that all assets are valued either on the assumption of the continuation of the company or the assumption of liquidation and are entered into the notional balance sheet. This includes both tangible and intangible assets as well as passive assets (debts). The net asset value is then the net worth (equity capital) stated in the balance sheets. The valuation is generally performed at replacement costs.
In practice, the net asset value is only significant if required by the company’s contractual clauses or for taxation purposes. Specifically, the company’s net asset value then forms the lower valuation limit pursuant to the German Valuation Tax Act (Bewertungsgesetz).
12. Non-operating assets
Assets not required for the original operation of the business must be valued separately and then added to the value of the company. This includes, for example, undeveloped property, residential rental property, works of art, etc. Thorough differentiation is required here. This is because the corporate planning for the operational business may not include any income or expense items associated with the non-operational aspects.
13. Tax procedures
Unlike how it used to be, there is no longer an independent review process in place for taxation purposes. The Stuttgart method used to be in place in various legal manifestations (German Property Tax Guideline of 1995, Inheritance Tax Guidelines of 2003). The German Valuation Tax Act basically sets out that companies traded on the stock exchange be valued at their market price. All other companies are valued at the value of the company as determined by the commercial method.
However, this can be simplified in the form of a simplified German income approach. The simplified German income approach is based on the assumption that the future income will correspond to past outcomes. This is assigned a statutory capitalisation rate or a rate set out by legal ordinance on the basis of which future earnings are discounted. Compared to the complete commercial valuations, this method may lead to significant delays.
Because of this, every fiscal valuation must include at least an indicative determination of commercial value so as to ensure that no excessive taxation occurs.
14. Combined method
In practice, various recommendations are made for valuation. These come together to form a total value from different valuation methods. These almost always involve combined methods. The most well-known variant of this was the Stuttgart method, which used to be used in taxation and which was comprised of an asset value (net asset value) and an earnings component (income value). These kinds of valuation methods have no basis in business administration. We are fairly sceptical when it comes to these methods of valuation.
15. Expert-conducted judicial company valuations
Company valuation is not performed in a legal vacuum. Valuations for tax purposes may be consulted during subsequent procedures under fiscal judicial review. In the event of inheritance disputes, statutory share suits or the distribution of surplus as part of divorce proceedings, these company valuations are regularly collected by experts, recognised by the court and ultimately determined by judgement.
The same applies if a company is bought or sold. This regularly involves the liability of the business’ institutions or supervisory board. Against this backdrop, expert-conducted company valuations must be legally sound. The particular occasion for the valuation and, where applicable, the circumstances in the company’s jurisdiction must be taken into account.
16. Expert reports/counter-assessments
If an expert-conducted company valuation is present during a contested dispute, for example, in court, this need not be accepted if the report is incorrect. In these cases, a counter-assessment or at least a pointed statement that demonstrates the report’s weak points.
In this context, the role of the evaluator is crucial. Whilst an auditor is required to be neutral pursuant to the provisions set out in Section 43 of the German Public Accountant Act (Wirtschaftsprüferordnung [WPO]), the solicitor or accountant may also present a so-called argumentation report that represents a biased view and takes into account only the interests and concerns of one litigant. This made be recommended directly as part of a contested legal dispute.
17. Duration and costs of company valuation
Based on the above, it follows that a company valuation represents a comprehensive advisory task. It involves a process that often needs to be performed and managed by a team of experts. The quality of the information provided to the evaluators may reduce the processing time and, with it, processing costs. Experience has shown that processing times for company valuations will likely range from a few weeks to several months.
As a rule of thumb for determining the fee for the company valuation, we calculate four to six times the cost of annual financial statements with appendices, preparation, reporting and tax declarations. Depending on the individual case, this may be considerably higher or lower. In practice, we compile a fixed price quote following an extensive initial consultation and based on any subsequent data and information collected.