The central theme of financial management is maximising value.
Across geographies, business decisions are made in the context of political, economic, social, technological, environmental, and legal factors, etc., some having higher influence over others in different situations. Owners and other stakeholders of the company need to understand whether the decisions have created the right outcome at the relevant time, or any course correction is required to meet the overall objective.
Corporate valuation/business valuation helps the stakeholders to identify the fair value of a business at a given point in time. Fair value is the price both the buyer and seller agree to exchange for an asset at a given point in time, the asset being the company itself.
The value of a business need not be the same for different parties; rather, it depends on how the company fits into their scheme of things. E.g. A strategic investor/buyer would accept a higher valuation for a company depending upon the factors like synergy, faster market penetration, etc., whereas a financial investor might assign a different value depending upon their focus areas, which also includes the exit plan.
Valuation is also a combination of art and science. Even though the scientific principles create the valuation framework, it takes an artistic form at some level, as the ability to quantify uncertainty at the macro and micro levels differs from one investor to another.
Valuation is done at different stages of a company’s lifecycle and by various parties. Below are some of them:
For companies at an early stage, raising capital is a challenging exercise because of the business risk associated with the early stages. This includes the ability to create a market presence for its products/services for initial survival and the ability to achieve various performance targets, including market share, revenue, operating costs, profits, cash flow, etc.
The external investment partners of an early-stage/late-stage include private investors such as Angel investors, Venture capital, and Private equity. They value the businesses commensurate with the risk they incur.
Through the above exercise, the owner and the management team understand the perceived value of the company from external investors. It also helps them to get a view of external investors on whether the future business plans are value-creating.
Companies that want to access the public market after achieving a particular size would like to raise capital from public investors (both institutional and retail) by issuing shares. A pertinent question here is, “What is the price to be offered to a large number of public investors?” In this context, the company does valuation internally (along with investment bankers) and arrives at a range of prices.
An exercise called book building is initiated to ascertain the value per share. Here, public investors have the right to identify a company's total value and the price per share based on the proposed range. This is the predominant method used in most developed and emerging markets.
Companies adopt different paths to growth. Both organic and inorganic growth options are pursued by companies at different stages. Both options have their own advantages and challenges. If acquisition route help companies to build capabilities much faster compared to a green field expansion, it might have a higher cost. Ascertaining the value of the target company is also based on the ability of management to create positive synergies post-acquisition. This becomes an important factor in deciding on the target company from various alternatives.
The role of valuation in portfolio management depends upon the investor's investment philosophy. Active portfolio management involves adding undervalued stocks into the portfolio and removing overvalued stocks to generate good returns. Hence, for listed companies, valuation is a dynamic and continuous exercise. In an efficient stock market, the price of a stock is expected to be a better reflection of the underlying fundamentals of the company, industry, and economy. This is one of the major advantages of listing.
In the world of geopolitical realignment, integration of artificial Intelligence for productivity and innovation, renewed thrust on businesses response to climate change, better monitoring mechanism through regulatory intervention and investor activism, it is important for companies to know it’s worth to stay relevant.
Value creation is a marathon exercise. Value-creating businesses contribute to society by adding innovative products/services to people, providing consistent employment and wealth, and generating risk-adjusted returns for investors so that they remain true corporate citizens of the country for a long period of time.
A great company has different investment partners during its life cycle. Different partners assign different values depending on the fundamentals of the company as well as the type of association. Many investment partners join for a short period, some stay a little longer, and others continue to remain with the company for a longer period.
Participants of the Executive MBA program are drawn to the world of valuation and value creation through an elective course, Corporate Valuation. The objective of this course is to make the participants understand the tools and techniques required for valuation and various factors influencing the value, thereby improving their ability to create value-creating business decisions consistently.
Rajesh Madhavan, Adjunct Faculty at SP Jain Global, has more than 30 years of experience, which includes teaching/training and consulting. He teaches finance across EMBA, MGB and GMBA programs. He holds an MBA degree from Philadelphia University (currently Thomas Jefferson University).
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