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More Important Than Valuation Methods: Value Creation
Before I delve into valuation methods, let’s take a look at the fundamentals. There are a multitude of factors; we typically work with over 25 variables that are more or less interdependent and objectively measurable. For simplicity, these can be divided into the three main areas that contribute to a company’s value:
• Market position and competitive advantages, as well as their sustainability
• Current and projected market conditions
• Financial strength, financial results, and changes therein
Taken together and within the framework of a more structured process, these can be used to calculate the actual enterprise value. However, this is merely a snapshot. The exercise only becomes valuable when viewed over time. The calculations have the potential to highlight where efforts to improve are worthwhile. Systematically addressing these factors well in advance of a sale—and considering how to enhance the value of one’s own company and ensure readiness for the sale—has nothing to do with short-term “window dressing.”
In a well-prepared, structured process, entrepreneurs and their executives can develop potential and close gaps—provided they are given sufficient time and the opportunity to do so. Buyers do not like surprises during the due diligence process (and, of course, even less so afterward!), so both sides benefit from a process that is planned for the long term and carefully thought through all the way to the end (closing).
In a hypothetical transaction with an assumed enterprise value of, say, €50 million, discounts in the seven-figure range can result if the second tier of management is inadequately staffed. Addressing this issue early on is significantly less costly and, overall, more attractive for both sides. This simple example shows that this is by no means a zero-sum game—where what one party gains, the other loses—but rather a situation where both sides can win.
Another example: a new business line with a solid track record of early success—provided it is not too far removed from the core business—has the potential to legitimize expansion plans, which in turn are factored into the valuation. The difference, for example, between 8% and 16% sustainable growth—not uncommon in the software industry—can quickly amount to a €5–10 million difference in enterprise value. That’s a substantial sum for a medium-sized company. On this very point, it should be noted: “Growth trumps everything,” as long as it is sustainable and verifiable. Any valuation method will demonstrate this. And, at the end of the day, these are merely tools to make the value comparable and to substantiate it with sound evidence.
Caution Regarding Common Adjustments to Calculation Bases
And then there’s the issue of adjustments to the initially determined enterprise value—better known in technical jargon as “EBITDA adjustments” and “equity bridges.” What is a nightmare for one party—typically EBITDA adjustments for buyers and equity bridges for sellers—is, logically, the exact opposite for the other party. Both parties are well advised to select the respective bases for these adjustments in a well-founded manner and in a way appropriate to the scale of the transaction. In protracted negotiations, the time invested in preparing, calculating, verifying, and defending these figures often doesn’t really pay off, and one is better off moving forward; the “real” market—satisfying customers, employees, and the supply side—is, as we all know, not one to wait.
Of course, it is true that, as long as no external parties are involved, entrepreneurs manage profits differently than, for example, a private equity firm. There are many reasons for this, and tax considerations are usually not the most important ones. However, it is equally understandable and justified, when determining a company’s value, to present the profit base adjusted for third parties. Examples include owners’ salaries—which may no longer be incurred or are only partially incurred—expenses related to the sale of the company, and sponsorship that demonstrably does not promote the business. Over the past 20 years, we have seen many expenses that cannot be directly attributed to operating activities; the list could go on indefinitely.
It is the M&A advisor’s responsibility in both cases to clarify the situation, assist with data collection and presentation, and negotiate all relevant factors. If he or she fails to do so, the client is left confused. The issues can be quite complex, and opportunities to increase or preserve value can easily be missed.
The Methods and Conclusion
So how do you measure total enterprise value? All the traditional methods for this are very well documented (Wikipedia, ChatGPT), so practical application is more valuable than a theoretical treatise on the subject. It is advisable not to rely solely on a single method. A useful approach has proven to be a balanced mix of the more external perspective (multipliers) and the internal perspective (net present value of discounted cash flows). This analysis will yield a fixed value or range, which must then be adjusted based on the company’s financial situation.
However, as mentioned at the outset, while this analysis can reflect a company’s value, it only truly gains significance when used strategically—that is, over time to build value. Every company is unique due to the distinctiveness of its value chain. And—despite the importance and value of balance sheet strength, patents, production facilities, brands, etc.—it is the people, their skillful application, motivation, and abilities that significantly influence value, and a discounted cash flow analysis falls far short of doing justice to that.
At the end of the day, the final price is ultimately determined by a buyer’s willingness to “put money on the table.” Regardless of what valuation methods indicate, this also depends on the buyer’s strategic interests, self-interest, passing trends, competition, and alternatives.
In this respect, focusing on potential buyers and their interests is just as important as the structured internal work required to increase the company’s own value. This, combined with a transaction process that attracts a healthy number of bidders, provides a solid foundation not only for achieving an above-average price but also for jointly creating value for the buyers.
As strategy and M&A consultants, we have observed and supported hundreds of transactions. One thing has become clear to me: the price achieved is central to both parties. But if the overall value and the process aren’t right, then even the best, toughest, and most cynical price negotiation is of little value.
