Valuation Approach as a Starting Point: Quantitative vs. Qualitative
Key-figure-based valuation models are also used in transactions involving small and medium-sized enterprises (SMEs) with the goal of determining the presumed fair value of the company.
The DCF method focuses on the company’s future cash flows and attempts to extrapolate the future from historical data using assumptions and projections; however, as the size of the company decreases, the view into the “crystal ball” becomes increasingly clouded. Consequently, multiple-based, history-oriented methods are frequently used. However, this simple technique is fraught with several conceptual weaknesses. By virtue of its starting point—the “law of one price”—this method fundamentally requires a comparison of identical companies. In the absence of suitable comparables, average, size-independent multiples for an entire industry are often used as a substitute.
It remains to be seen to what extent quantitative or financial-mathematical valuation methods alone lead to an optimal result for all parties involved. Certainly, the many different methods and valuation approaches all have their place, and as a company grows in size, quantitative methods also become more precise.
From our perspective, however, particularly in the mid-market or SME segment, significant aspects relevant to the purchase price or valuation are very often overlooked. Among other things, risk profiles fall short, niche positions are scarcely evaluated, and market potential is often defined too narrowly.
In our view, the true enterprise value can only be determined by giving due consideration to qualitative factors. The challenge lies in finding the right partner or buyer. This partner must a) understand the business model, the specific characteristics of the niche, and the market environment; b) be capable of developing the company within this framework; and c) be willing to pay a price that reflects these opportunities and potential.
The M&A Bidding Process: The Standard Approach
As part of an M&A process, a broad-based bidding process is typically organized by an experienced sales expert; in academic circles, reaching out to as many potential acquirers as possible is regarded as a guarantee for achieving high sale proceeds while ensuring the best possible transaction security.
While reaching out to and involving both financial investors and strategic acquirers (including competitors!) does increase the likelihood that a buyer will emerge from the sales process, At the same time, due to the lack of bilateral “intimacy,” this format severely limits the seller’s willingness to provide a high degree of transparency (e.g., customer names and structure) during the due diligence process. Often, key qualitative characteristics of the company are neither sufficiently examined nor properly evaluated.
Furthermore, in a broad-based sales process, plant and site visits by a number of potential acquirers can lead to unease: word of the sale spreads quickly within the industry; and customers, suppliers, and employees alike begin to wonder whether the potentially successful bidder is actually the right choice for the company’s continued existence. A company sale with—by definition—an uncertain outcome can lead to widespread unease, which, in the worst case, can result in the departure of the aforementioned stakeholders.
What would be an alternative? The bilateral sale process
Particularly when selling medium-sized family-owned businesses—which likely experience an M&A process only once in their history—a “more gentle approach” toward the organization and all parties involved is advisable. As an alternative to a competitive sale process, bilateral discussions with (initially) only one party can be a valid option. By granting a time-limited exclusivity—which provides planning certainty for both sides—the parties can first get to know and appreciate each other better and thus determine whether there is a strategic, cultural, or other fit. Together, the parties can thus identify the appropriate strategy, the appropriate structures, and consequently a fair purchase price or an adequate valuation for all parties involved.
The process can be adapted to the organization’s “pace” without disrupting day-to-day operations. Maintaining confidentiality proceeds more smoothly due to the sharing of potentially sensitive company data. In many cases, the “more relaxed timeline” also allows for a higher degree of transparency regarding competition-sensitive and qualitative factors, which can be particularly advantageous for the seller and may also be reflected in the determination of an appropriate purchase price.
Evaluation of the Two Processes
The right sales process depends entirely on the company and its specific situation. The risks of a bilateral sales process should not be overlooked: if one prospective buyer drops out, the process starts all over again. In some cases, the seller may also lack the ability to compare the proposed transaction structure with others.
In our view, the challenge of a sales process therefore lies in optimally balancing the conflicting priorities of transaction security, purchase price, the burden on the organization, the impact on various stakeholders, and transparency—all while maintaining confidentiality.
This can be mitigated by an experienced M&A advisor who is well-versed in all aspects of a company sale. Such an advisor can represent and balance the various interests both in an organized bidding process and, alternatively, in an exclusive sales process.
PEBCO Aktiengesellschaft is a management consulting firm and service provider specializing in strategy, markets, business processes, and finance. The design and active implementation of succession planning processes are central to its work. As an “enabler for small and medium-sized enterprises,” the company deliberately positions itself as a generalist in order to develop holistic solutions for overcoming growth barriers. Since its founding in 2015, PEBCO AG has grown to a team of four partners, supported by a stable foundation of senior and junior consultants. The Financial Advisory, M&A, and Private Equity divisions—which have been further expanded in recent years—round out the company’s range of services.
