A New Valuation Approach

As a partner of IMAP, a global M&A partnership focused on the middle market with over 60 offices, Assay contributes research and thought-leadership in addition to assisting our partner firms with cross-border transactions.

For IMAP’s first issue of Creating Value, Mike Simson, Partner at Assay Corporate Finance, contributed the following article detailing Assay’s innovative approach to valuing businesses.


“While profitability is an important influence on a business’s equity value, it is not the only determinant”


There is more than one way to appraise a business. IMAP in the UK has a unique approach to helping you increase the sale value of an owner-manager’s life’s work. Profit growth usually tops the agenda for mid-tier businesses wanting to increase sale valuation. But this common approach to increasing a business’s equity value often takes substantial effort, e.g.; in initiatives such as lifting sales through recruitment and training or opening new premises. While profitability is an important influence on a business’s equity value, it is not the only determinant. We regularly help clients increase the value inherent in their business through a focus on assets, as well as profits. Without an asset understanding, mid-tier businesses tend to favour
a purely financial based valuation. This means many owners lose a vital opportunity to increase value, and therefore, they inadvertently undersell their businesses.

Most owners are familiar with the business valuation equation: V = P x M, where the valuation (V) of a business equals profit (p) times a multiple (M). If profit is £10m and the valuation multiple is five, then the company is valued at £50m. The multiple is simply a measure and judgement of future profits. The greater the likelihood of future profits the higher the multiple, low probability reduces it.
Sounds easy in principle,
but there is more to this apparent simplicity. The finance-based approach to valuing a mid-tier business is retrospective, typically averaging the last three
to five years’ profits and applying a financial rate of return. Effectively, the buyer purchases a historical cash flow where the multiple ties into the likelihood – the risk – of that cash flow continuing. This accounting approach is widespread and a legitimate business valuation method. But an alternative approach focuses on the valuation multiple rather than profit alone.

For example, Instagram sold for a billion US dollars but had never produced any revenue. The value of the business was in its “off- balance sheet assets”, its mobile app and the massive user base through which Facebook believed it could sell its own products and services.

“Off-Balance Sheet assets may not have generated profits historically, but they will do so in the future”


Our research has shown that in each industry there is a multiple which is regarded as the norm. Businesses in the same industry with similar market share, turnover and profitability, would typically attract the same multiple – the norm,
or what we call the ‘line’.
The traditional finance-based valuation approach starts on the ‘line’ and then looks ‘below the line’ for risks that justify lowering the multiple and the value along with it. In other words, the multiple are discounted because the business risks suggest that future profits are uncertain. We call this a
‘two dimensional’ valuation approach. In contrast, let
us proffer a prospective, asset-based approach. While we do look retrospectively at profits, we are equally
as interested in what the business will generate in the future.

Aboe below the line

Our ‘third dimension’ approach reveals what is ‘above the
line’, the so called off-balance sheet assets. These are not necessarily booked on a typical balance sheet alongside plant, equipment, property, vehicles, etc. Off-balance sheet assets may not have generated profits historically, although they will do so in the future. Or more importantly, they will generate future profits in the hands of a strategic acquirer. Take the tech company that never made a profit yet still sold for millions of dollars. While the company may not have made a profit, perhaps it has an asset comprising a large user base through which a strategic acquirer could sell its own products or services. That’s strategic acquisition. The buyer would therefore pay an equity value that ignores the company’s historical profits. In this case the business’s multiple has burgeoned – increasing the likelihood of future profits – and therefore calls forth a higher overall valuation.

Case studies show that businesses adopting an asset-based approach to valuation sell for significantly more than their industry multiple norm would presume. A traditional finance-based acquirer will typically only pay four or five times the norm. Contrast this to the strategic acquirer, who will pay a higher valuation multiple. The business has not changed in these cases, but the buyer’s perspective of it (and the multiple) has.

We often find clients have created profit motive-based business assets, and therefore, they do not value their assets strategically. For example, imagine your business has developed a truly innovative system for boosting margins and volume through process efficiency – a profit motive. A strategic acquirer, rather than
a traditional finance-based buyer, would be interested in your system because they could apply it to their other businesses. Adopting an asset-based approach in this way increases the multiple, and therefore, the valuation of your business.

When working with our mid-tier business clients, we begin by discussing their initiatives to increase their valuation before sale. Understandably, people tend to focus on the ‘P’ aspect of V = P x M because they know how to influence profit. Clients often say, ‘If I increase profits then I’ll get my valuation up.’ While this is true, it misses the other valuation lever – the multiple. While business owners know that profit equals volume times margin, they typically do not have the same level of understanding about the multiple formula. During the valuation conversation, we explain how
a client’s (typically off-balance sheet) assets have the potential to increase future profits while identifying any factors that could diminish them. In other words, what ‘above the line’ business features should be recognised and formalised? Also, what ‘below the line’ issues pose risks to future profits and therefore must be addressed? Our aim is to sharpen your awareness of the assets you have, assets you may not currently recognise as such – assets with the potential to attract a strategic buyer and swell your multiple. Hiking
the multiple takes less energy than battling to lift profitability.

“Our aim is to sharpen your awareness of the assets you have, assets you may not currently recognise as such – assets with the potential to attract a strategic buyer and swell your multiple”


Why? Because you probably have the assets that will attract a strategic buyer.

Supporting a business through an asset-based approach to valuation can be summarised in three steps.

Step 1: Value the business now!
Business owners do not typically have an accurate idea of their current business valuation. This leaves them feeling reactive and praying they have something that will eventually be saleable. The first step is to perform a pro-forma valuation to give the owner an objective valuation of the business. The owner then becomes proactive, not reactive, by informing the starting point for building on the business’s equity valuation.

Current business

By understanding more about strategic acquirers and business valuations, owners can build a strategy to move from its current valuation to a targeted exit valuation.

Step 2: Define the exit vision
Step two defines a minute exit vision, which involves tabulating the valuation and timing the exit. While owners often have an idea of their targeted valuation at exit, they rarely have a deconstructed formula to arrive at that figure. For example, a business with a £60m exit vision valuation could arrive at this number using either option below:

Each of these options requires a significantly different strategy in their application.

Valuation example

Step 3: Design an equity enhancement programme
Step three identifies the stepping stones for shifting a business from its current conventional valuation to a targeted exit valuation. These stepping stones are a combination of strategic projects, initiatives and potential interim transactions. Specific focus is given to strategic projects/initiatives that will enhance the business’s valuation multiple. These are identified during the detailed ‘above and below the line’ analysis explained earlier. Along this path clients become more aware of the business assets that will appeal to a strategic (rather than financial) acquirer. Armed with this information, and increased knowledge of strategic investor language, clients are more confident and effective in conducting sale negotiations. Now they can offer more than a historical profit-based valuation.

The market for mid-tier business sales during the 2008-2012 global financial crisis was extremely flat. However, now that economic conditions are improving, previously unsold stock is re-entering the market. Coupled with this fact, the retiring baby boomers are also looking to sell their mid-tier businesses in ever increasing numbers. We are witnessing these two converging waves of stock coming up for sale. As a consequence, sell-conscious business owners will soon find themselves competing in a very crowded space.

If you are looking to sell
your business, how will you stand out in this increasingly crowded market? Understanding your business assets – and which ones will lure a strategic acquirer – enhances your position far more than a conventional financial-valuation-based sale approach.


To discuss any issues around this article or if you are formulating your exit plans please contact one of the team.