Question

You are a senior member of management for a development and construction company where the original two owners wish to retire and sell the business. Along with several experienced co-workers, you are considering a buyout of the business. As part of your due diligence, you have performed some analysis of the historical financial statements and determined the following:

·         Audited financial statements indicate a net book value of $4,500,000.

·         The owners recently had the tangible assets appraised and the fair value of assets is $2,000,000 higher than audited book value. Part of the difference results from the owners having acquired several development sites over a period of years that are recorded in the audited financial statements at original cost.

·         A guideline public company recent price to earnings multiple for a comparable public company times weighted average income results in a business value of $9,000,000.

·         Using a discounted cash flow approach with a five-year projection period and terminal value results in a business value of $10,000,000.

You and your co-workers have offered $9,500,000 for the company. The owners will be paid consultants for one year following the purchase of the business so that there will be no loss of key employees.  

The owners are motivated to sell but negotiations are at an impasse. The owners insist that they be paid $11,500,000 - $9,500,000 offered plus the $2,000,000 incremental fair value of assets over book value. How do you respond to the counter-offer of the owners? Explain briefly the reason if you accept or reject the offer

Answer 1

Business can be valued on following three basis-

1)Net assets valuation basis

2)Price to earning or sale basis

3)Discounted Cashflow basis

In the given case Realisable value of assets are $2000000 more than the book value of the assets.In case of valuation of business by Net asset method valuation can be done on book value basis or market value basis but then liabilities should also be considered at market value.It may so happen that market value of liabilities are also high.

On the basis of PE multiple company valuation in comparison to any other rival firm is $9000000 and on the basis of discounted cashflow it is $10000000.So the offer by the owners can't be accepted.$11500000 is too high.Maximum $10000000 can be offered in place of $9500000.

It is also notable that the will get paid for the consultation after the purchase of business so such extra premium can also not be asked for their services.