624 Making Key Strategic Decisions
- Have annual financial statements audited or reviewed by a certified pub-
lic accountant and improve interim financial reporting (lowers buyer risk
of inaccurate financial statements). - Develop a list of potential synergistic buyers and identify the ones with
the most to gain from an acquisition of the subject company (search for
the highest synergistic value to be paid). - Decrease dependency on major customers and vendors (lowers buyer risk
of earnings volatility in the event of the loss of any of these customers or
vendors). - Begin assembly of key business information for potential buyers (lowers
buyer risk of perceptions of potential earnings volatility without having
such knowledge). - Improve any existing poor financial statistics or ratios (lowers buyer fi-
nancial risk).
Public companies report earnings and performance on a quarterly basis
and the share prices frequently react quickly. On the other hand, private com-
pany values generally react more slowly to changes. Thus, management may
need to work on value improvement factors one to two years in advance of mar-
keting a business.
SUMMARY
The fair market value of a private business is essentially an estimate of the
price that a willing buyer would pay and a willing seller would accept. Buyers
have different motives for buying a business. Financial buyers are looking for a
return on their investment. Strategic buyers are usually looking to integrate
their company with the business for unique strategic reasons. Financial buyers
pay fair market value while strategic buyers usually pay a price ref lective of
the unique strategic advantages to the specific buyer. Often, strategic buyers
pay more than fair market value. Although it is possible to conduct a business
valuation that is not overly complex, the question remains whether the result-
ing value is accurate. Many variables go into a valuation analysis. A business
valuation is both a quantitative and qualitative process that is focused on as-
sessing investment risk and investment return. It is largely an assessment of the
risks a buyer is taking in acquiring and owning the company. In addition, a val-
uation attempts to project the earnings an owner of the business can expect in
the future as a return on investment.
Author’s Note. This chapter is not intended to be a complete text on business
valuation. It is meant to illustrate through examples many of the fundamentals
of business valuation and their application. The proper application of valuation
theory depends on the actual facts and circumstances of the investment being
valued.