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Business valuation is still a mystery. “You can’t really challenge the worth of a business,” or “Every business is so unique that no one could ever put a justified value on it.” Both of these statements shows the fact that professional valuators have put decades to perform accurate business valuations but still they find it’s not a dart game.

All of the processes that make up company have a cost. Culture, key management, labor, overhead, inventory, capital, goodwill, employees, patent, copyright, and even human relationships. All of these have a value associated with them. Some assets are so unique that it’s very difficult to put an even range of value them. In fact, if any of the elements are missing probably it’s possible that we will not be able to justify the value of the business. So judging and considering every parameter in the valuation is important.

In these turbulent times or in an exponential growth period, the normal methods of valuation of businesses don’t fit.

Net Asset Value, Sum of Parts, Discounted cash flows, multiples of future revenues – nothing seems acceptable. So many businesses are available at below its book value of assets and has dividend yield as high as 8%. So it is like equilibrium in economics, which is just in theory, but rarely that is achieved. So almost all time we may not arrive at right valuation using only one of the various financial models. So, that makes us not believing in projections of a target as things are so uncertain. Now the big question is if it is not science then how to go about it.

There is a myth that determining the value of a profitable company is simply a matter of mathematics. Really this myth only is helping various transactions getting executed, because both buyer and seller arrive at the different value of the same business.

The word value means different things to different people and the result will not be the same, should the context change. A valuation is not an exact science. The value is a subjective term and can have a different connotation. Valuation involves the use of professional judgment, knowledge of business, analysis of facts, interpretations and use of different methods and procedures, which may result in a different value in each given situation. This implies that the business value must be measured and defined by a ‘standard of value’ that is relevant, meaningful and reliable. Before applying any of the accepted methods in the course of valuation of any business on going concern basis one need to look at and consider many factors which are subjective and not objective as in the case of quantitative models. We list below some of them :

The use of professional judgment is an essential and most important component of estimating value in all cases. Further in most cases, values arrives at a range of values and not just one value.

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The very first thing which we need to consider is the purpose of the transaction for which we are doing valuation- is it a Merger, Demerger, Acquisition, Sell-off, Distress assets sell-off, etc. As valuation approach in every case will be different because every transaction is unique and require specific consideration at the time of valuation. Crompton Greave’s recent decision to buy 41%stake for Rs 2.3 billion at par value in Avantha Power and Infrastructure (APIL), a promoter group company was considered destroying value , though based on any quantitative model one may arrive at a figure which adds value . On the day of the announcement, Crompton Greaves’s share price declined by more than 27%. The market actually saw value erosion and reacted like this.

What is the type of the transaction- strategic or financial, 100% buyout or partial stake, whether the present management will continue etc. should be considered. Sometimes it may be necessary that the acquirer would like the present management of the target company to continue because the existing management has a strong relationship with the customers and vendors and there is a probability of losing the business if management changes. The cost of retaining the present management shall also form part of the purchase price. How much to be paid for retaining is critical and actually require a lot of understanding of the importance of the present management in business dynamics. The acquirer should also see that whether the past baggage of the target is required to be bought. The hidden liabilities also need to be identified. The purchase price has to be adjusted accordingly.

Mode of consideration is another aspect which also gets factored in the purchase price. The purchase price in case of modes such as hard cash, equity shares, preference shares, bonds, Royalty or conditional consideration may be different.

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“Which method to use and why” is equally critical. Should we consider Asset base of the target or its business prospects of the company or intangible of the target or combination of all- It depends on ? All these approaches have various variables such as market value of the assets, marketability of the assets, optimal use of the assets, cash flows, risk premiums etc. we can see in the asset based the art is deciding the book value or Market value of assets as currently the book value of Jute Mills is higher than the market value. Estimating all these is beyond statistics and justifying appropriate one out of several methods is a really a challenge and needs real art. For example, what risk premium should we use in this economic scenario? Should the risk premium be same for all the companies falling in the same industry, Doe a micro picture of the target company has a role to play in this and so on.

So, transactions have to evaluate the value creation for everybody in the system so coming out with the valuation which creates value for everybody is an art, not science because science can not consider the subjective parameters in the valuation.

Let us study a case of Tata Oil Mill Company Ltd’s (TOMCO) merged with Hindustan Lever in 1993. This particular case used three valuation methods- The yield value, the asset value, and the market value of the shares of both the companies and appropriate weight ages were given to each of the above values. The valuation figure arrived by the valuation expert Mr. Malegam was less than the book value and the employee union took the company to the court challenging for the valuation, however, later on, Supreme Court stood on Hindustan Lever side for the valuation figure. In the Yield valuation method deciding the profit figure and a profitable year is an art as we can see that Mr. Malegam artistically decided the profitable year for TOMCO as the company was making losses in two preceding previous years and made above normal profit in 1991. Therefore, he considered years before 1991 which was showing stability in profit for arriving at the valuation.

“Who is the buyer”, also plays a critical role in the valuation. A foreign company acquiring in India shall be ready to pay for the entry premium and for saving on the gestation period. Only simple projection of cash flow of the target company shall not justify the value for the acquirer. How much entry premium has to be paid is probably the main concern and justifying it for the values is a real task.

To conclude, Value lies in hands of beholders. A diamond in the hand of a diamond merchant is more valuable than in the normal hand because he understands diamond better than the normal man. Valuation changes every time, every day as company information is dynamic. Factoring the qualitative aspects is critical. It is a MODERN ART. Can anybody develop a standard approach to art? Irrespective of that one thing is certain that only artist can be successful values.

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