The 4 methods in practice

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Question

Answer

For precedent transactions and comparable companies, you take the median of the set and then apply that multiple to your company.

DCFs and LBOs provide more precise values and you can use sensitivity analysis to create a range based on the variance of key variables.

Then once you have all four types of valuation, you can look at the maximum, minimum or percentiles to create a range. This concept of a range is really important, when a candidate thinks that valuation is precise and that as bankers you can determine that a business is worth “x” down to decimal, it’s a big red flag to me in terms of conceptual understanding.

Transactions are unique and every buyer has unique factors that would change their value of the company. Your goal as a banker is to get down to a reasonable range, typically with a 10-15% variance so you can understand and communicate to your client what kind of valuations make sense and are not under-valued.

It’s to say “we think that the business is worth $400mm - $450mm” and see if that is attractive enough to a client to pursue a sale. From there, you should have a good idea when a company is low-balling you and when something is a fair offer. This lowball point is key, the aforementioned client would never be upset if they got offers in the $500mm range, but if they came in at the $300mm range, it may not be worth selling to the client and months of time and effort from both the client and the bankers would have been lost.

🏦 Why is this important to bankers?

In order to communciate valuation to a client, or evaluate it internally, you must synthesize all four methods. Normally, these are displayed in a football field slide, which we will be showing an example of later in the course.

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