Valuation is the process of determining the worth of a business or financial asset, and it involves a significant amount of judgment. In India, only a Registered Valuer, registered with the Insolvency and Bankruptcy Board of India (IBBI), is authorized to provide a valuation report for purposes defined under section 247 of the Companies Act, 2013, and the Companies (Registered Valuers and Valuation) Rules, 2017. Such purposes include mergers and amalgamations, capital issuance, and the issuance of sweat equity shares, among others.
Methods of Business Valuation
1. Income Method (Discounted Cash Flow)
Use Case: Ideal for a going concern with positive cash flows.
Approach: Based on future free cash flow projections, discounted back to present value using the Weighted Average Cost of Capital (WACC).
2. Market Method
Use Case: When market comparables are available.
Approach: Involves comparing the target company with similar companies that have been valued by the market.
3. Asset Method
Use Case: Suitable for liquidation scenarios.
Approach: Values the business based on the value of its net assets.
Steps in Valuation Using the Income Method
Calculate Free Cash Flow (FCF):
Use Profit After Tax (PAT), add back depreciation and interest, and adjust for changes in working capital and capital expenditures.
Project FCF for the explicit period (e.g., 5 years).
Determine WACC:
Calculate cost of equity using the Capital Asset Pricing Model (CAPM) and cost of debt using after-tax interest rates.
Adjust WACC for factors like liquidity and country risk.
Discount Cash Flows:
Discount the FCFs to their present value to get the NPV for the explicit period (e.g., $22 million).
Calculate Terminal Value:
Use Gordon’s Growth Model to estimate the terminal value and discount it using WACC to get its NPV (e.g., $78 million).
Compute Enterprise Value:
Sum the NPVs from the explicit period and the terminal value (e.g., $100 million).
Market Multiple Method
Identify Comparable Companies:
Select publicly traded companies with similar characteristics.
Calculate EV/EBITDA Multiple:
Use the multiple from the comparable companies (e.g., 20).
Apply Multiple to Target Company:
Multiply the comparable company EV/EBITDA by the target company’s EBITDA to estimate its Enterprise Value (e.g., $90 million).
Comparison and Average:
Compare values from both methods, adjust for discrepancies, and derive an average (e.g., $95 million, with a range of $90 to $100 million).
Valuation of Startups
Startups with no profits or positive cash flows but substantial potential often command high valuations. New methods such as the Berkus Approach and the Valuation by Stage approach are used to value startups based on revenue growth, app users, technology, and intellectual property.
Conclusion
Ultimately, a business’s value is what the market is willing to pay. Currently, investors are very bullish, often giving huge premiums to loss-making, technology-enabled startups compared to older, profit-making companies.
