Authors: Kenneth H. Marks, Robert T. Slee, Christian W. Blees, Michael R. Nall
Publisher: Wiley Finance – 376 pages
Book Review by: Nano Khilnani
Investopedia defines “middle market” as that area or range of companies typically having annual revenues from $50 million to $1 billion. But it qualifies that the limit has not been set by any entity, so the lower minimum may be $10 million and the upper limit could be $500 million.
Companies in the middle market sector of the United States economy’s private sector could be contributing as much as two thirds to its gross domestic product. While total GDP is known to be around $15.2 trillion, we do not know much of that is the public sector or government.
(The government does not create and contribute new income to the GDP, but rather consumes it, so we do not know how to classify or measure the dollars it spends in the economy – we will leave that to economists)
Just like in the market where products and services are bought and sold, so are companies of all sizes and types purchased or ownership changing hands. The buyer may overpay or on the other extreme, get a company for a steal. It all depends on valuation and how that is done.
Valuation of a company is not just its net worth or sum of all its assets minus its liabilities. Part of the valuation could be its perceived future value or its potential. for revenue and profit. There are so many factors to consider when assessing value and in many instances, non-mathematical human factors play key roles in valuation.
A whole chapter is devoted to valuation and it is discussed throughout the book. I believe no issue is as important; the mechanics of acquiring a company of any size is well known and can be employed without much thinking, but determining value is partly but not an objective exercise; invariably there are subjective elements in it.
The authors state that private business valuation can be viewed through different standards of value and name at least eight of them at almost the beginning of the book in chapter 2. They state in many instances that valuation is both an art and a science, and investors think of risk and return when considering a purchase of a company.
It is different when it comes to public companies. Investor know the market value of a company almost instantly when they look at its annual report. Then they simply calculate
The worth of the shares they purchase by multiply the current market price of each share by the number of shares they buy through a stock exchange.
They are able to also determine other components of value of their shares by going over its balance sheet and income statement. What have been the average earnings per share over the last 10 years, as a percentage of its average price during that period? It’s all there in the annual report.
Buying a private company or a portion thereof is an entirely different matter. How do you assess its value in terms of its net worth and importantly, its resale value, if the motive of the buyer is to make a profit by buying the company below perceived market value?
For a buyer whose intention is to add value after purchasing a firm, he or she has to determine how much additional investment of money, effort and time is required to reach a pre-determined goal of value.
A thorough valuation of a company is, I believe, the most critical task a buyer needs to undertake when making a purchase decision.
The authors present in this book eight ways of valuing a private business. We briefly paraphrase below how they describe the basis for each type of valuation.
Market Value: This is possibly the highest value of a company compared to the other seven standards of value. But the authors point out that market valuation will vary depending on the type of buyer that is interested in purchasing it: the asset buyer, the financial buyer, or the synergistic (strategic) buyer.
The asset buyer will determine what the company is worth to him based on its net asset value, also known as net worth: total assets minus total liabilities, with no provision at all for intangibles like company brand, goodwill, etc.
The financial value buyer is interested in looking at its past earnings as a percentage of different fundamentals like capital, investment, and the like. He is interested in assessing the company’s future income stream. He looks at the firm’s EBITDA (earnings before interest cost, taxes, depreciation and amortization.
The strategic buyer will focus on what would be the combined value, which includes net earnings of both companies – what he already owns and what he plans to buy. If the products of both companies compliment each other and he can achieve net income beyond the current combined income, that would be a factor to buy.
Fair Market Value: This measure is based on IRS Ruling 59-60 and it is used primarily for tax and legal reasons, the authors point out.
Fair Value: This is used when there is dissent among shareholders, is not based on market value but a sort of compromise in two or more subjective estimations of value.
Incremental Business Value: This is the change in value based on generating revenues (or net income) beyond the corresponding economic costs, which includes cost of capital.
Investment Value: This is value typically for an individual investor in terms of expected earnings and return on his investment, expressed in percentage terms on an annual basis.
Owner Value: This is value attributed to the business by the owner, which often includes non-financial investments such as sweat equity, effort put over the years for the business to become successful, and perks received by him, his family members and relatives.
Collateral Value: This is the amount a lender would loan to a company with company assets (property, receivables, etc.) as collateral.
Book Value: The value of an asset as shown in the company’s balance sheet. It does not include potential deprecation or appreciation. For example, the company’s building as property could go up in value, but its machinery or plant and equipment is likely to depreciate in resale value.
This book has extensive coverage of many issues relating to mergers and acquisitions organized into three main parts and 17 chapters.
Part One discusses what the Middle Market is and its characteristics as compared to very small companies under $5 million annual revenues on the one hand and billion-dollar firms on the other end of the spectrum; and what valuation perspectives are used in it.
It covers many aspects of the company acquisition process, including on the international level. It presents two case studies for further enlightenment.
Part Two covers topics such as management of the acquisition process, legal representation on both sides (buyer and seller) and how mergers are done. It also discusses professional standards and ethics.
Part Three is on technical discussions on mergers and acquisitions. It covers deal structure and documentation, taxation issues, governmental regulation and compliance requirements, financing sources and due diligence. At the end of this section is discussion on market valuation of companies in its last chapter.
This highly valuable book is also quite comprehensive on many issues relating to buying and selling private companies in the mid-market revenue range. It is useful for those looking to buy or sell a company in terms of how to determine its value and come up with a purchase or sales offer. Its four authors have done a very diligent job.