Basic Knowledge - Unternehmenswertrechner
Basic Knowledge
Company Valuation
Company valuation in the succession process
Valuing a company is one of the most difficult but essential tasks in succession planning. However, different ideas of the purchase price between the previous owner and the transferee often lead to conflicts. The transferor often overestimates the value of his company, which he may have put his heart and soul into building up over many years. The transferee, on the other hand, wants to generate the lowest possible purchase price so as not to get into financial difficulties and possibly jeopardize the company's ability to service its debt. A transaction can only be successful if a price is achieved that is acceptable to both parties. In this fact sheet, we briefly present the most common calculation methods. However, different results are obtained depending on the valuation method chosen. There is no generally binding procedure. A company valuation should therefore not be carried out without the assistance of an experienced tax or business consultant.
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Determine the company value
The amount of the purchase price is often a reason for differences between the previous owner and the company successor. Determining the value of the company is therefore a crucial aspect of company succession. There is no absolutely correct and objective company value. As a rule, the purchase price is the result of lengthy, often tough negotiations between the seller and buyer.
The buyer is keen to pay the lowest possible purchase price. The selling entrepreneur, on the other hand, often overestimates the value of his company. This is understandable, as he has invested many years of effort and work in the company. However, the overestimation of value leads to a double danger for the company. Firstly, it will be difficult to find a successor who is willing and able to pay the high purchase price. Secondly, there is a risk that the successor will take on the financial burden of an excessive purchase price and the associated financing costs, or that the company's ability to service its debt will be exceeded. This would jeopardize the continued existence of the company.
In addition to the objective criteria, the subjective value expectations of the contracting parties also play a role in the sales negotiations. When determining the purchase price, not only the company value or operational factors play an important role, but also external factors such as the age of the seller and the buyer, the financial situation of the seller and the buyer, the buyer's willingness to take risks and alternative offers. When determining the purchase price, it should also be taken into account whether the company is being sold to a family member, an employee, an external buyer or an investor. This makes it clear that the value of the company can vary from different perspectives and taking different parameters into account. The term "value" is therefore quite ambiguous.
The buyer is keen to pay the lowest possible purchase price. The selling entrepreneur, on the other hand, often overestimates the value of his company. This is understandable, as he has invested many years of effort and work in the company. However, the overestimation of value leads to a double danger for the company. Firstly, it will be difficult to find a successor who is willing and able to pay the high purchase price. Secondly, there is a risk that the successor will take on the financial burden of an excessive purchase price and the associated financing costs, or that the company's ability to service its debt will be exceeded. This would jeopardize the continued existence of the company.
In addition to the objective criteria, the subjective value expectations of the contracting parties also play a role in the sales negotiations. When determining the purchase price, not only the company value or operational factors play an important role, but also external factors such as the age of the seller and the buyer, the financial situation of the seller and the buyer, the buyer's willingness to take risks and alternative offers. When determining the purchase price, it should also be taken into account whether the company is being sold to a family member, an employee, an external buyer or an investor. This makes it clear that the value of the company can vary from different perspectives and taking different parameters into account. The term "value" is therefore quite ambiguous.
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The evaluation procedures
There is no generally applicable procedure for company valuation that can be used to clearly determine the value of a company. Rather, there are various calculation methods. While the market price of listed companies can be determined by multiplying the share price by the number of shares, this is much more difficult for owner-managed small and medium-sized companies. In the following, we will introduce you to the most common methods for valuing small and medium-sized companies. These valuation methods allow approximate values to be determined and can be modified. In particular, a distinction is made between past and future-oriented methods. Ultimately, however, it is left to the negotiations between the transferor and successor to agree on an appropriate purchase price.
Income capitalization approach (classic)
In the capitalized earnings value method, the company value is determined on the basis of future surplus income. The decisive factor is what income the company can generate in the coming years in order to cover the purchase price invested in the medium term. The earning power and thus the ability to service debt are of key importance in a business succession. The successor must use the income generated not only to make the necessary investments in the company, but also to make interest and principal payments from the purchase price financing.
The capitalized earnings value method takes into account the investment alternatives of the buyer, who can either acquire the company with his capital or invest his money on the capital market.
The company valuation is based on the operating results of the last three past years, the current financial year and the budgeted figures for the next two years. The pre-tax profits should be selected due to different individual tax conditions. In the first step, the operating result of the past is adjusted for extraordinary and one-off expenses and income. This includes, for example, the imputed managing director's salary for individuals or sole proprietorships or the imputed salary of family members (e.g. if the wife writes invoices in the evening). Non-recurring income and expense items include special depreciation or insurance compensation, i.e. items that are not attributable to the direct business. The average of the adjusted and planned operating results represents the profit to be expected in the future.
In the second step, the expected future profit is discounted using the capitalization rate. The capitalization interest rate determines the interest rate that the investor expects from the valuation object, taking into account alternative investments with comparable risk. This interest represents the minimum return that the company must generate. The level of the capitalization interest rate is of great importance. This usually consists of two components: a base interest rate, which represents the interest rate of an alternative investment, e.g. in safe government bonds, and a risk premium for the internal and external entrepreneurial risk.
Due to the great importance of the capitalization interest rate, great care is required when determining and calculating it. A capitalization interest rate of 8% results in a present value (enterprise value) that is 25% higher than a capitalization interest rate of 10%. The question of the "right" capitalization interest rate is therefore synonymous with the question of the "right" future profit.
The enterprise value is now calculated by dividing the sustainable earnings by the capitalization interest rate.
The capitalized earnings value method takes into account the investment alternatives of the buyer, who can either acquire the company with his capital or invest his money on the capital market.
The company valuation is based on the operating results of the last three past years, the current financial year and the budgeted figures for the next two years. The pre-tax profits should be selected due to different individual tax conditions. In the first step, the operating result of the past is adjusted for extraordinary and one-off expenses and income. This includes, for example, the imputed managing director's salary for individuals or sole proprietorships or the imputed salary of family members (e.g. if the wife writes invoices in the evening). Non-recurring income and expense items include special depreciation or insurance compensation, i.e. items that are not attributable to the direct business. The average of the adjusted and planned operating results represents the profit to be expected in the future.
In the second step, the expected future profit is discounted using the capitalization rate. The capitalization interest rate determines the interest rate that the investor expects from the valuation object, taking into account alternative investments with comparable risk. This interest represents the minimum return that the company must generate. The level of the capitalization interest rate is of great importance. This usually consists of two components: a base interest rate, which represents the interest rate of an alternative investment, e.g. in safe government bonds, and a risk premium for the internal and external entrepreneurial risk.
Due to the great importance of the capitalization interest rate, great care is required when determining and calculating it. A capitalization interest rate of 8% results in a present value (enterprise value) that is 25% higher than a capitalization interest rate of 10%. The question of the "right" capitalization interest rate is therefore synonymous with the question of the "right" future profit.
The enterprise value is now calculated by dividing the sustainable earnings by the capitalization interest rate.
Discounted-Cash-Flow-Method
The valuation principle of the discounted cash flow method (DCF method) is basically the same as the capitalized earnings value method. A surplus figure is discounted to the present value. In contrast to the capitalized earnings value method, the DCF method uses future cash flow as the basis. The cash flow shows the amount of internally generated cash available to the company for investments, loan repayments, taxes, compensation for impending bottlenecks, etc. The cash flow can be calculated in different ways. Cash flow can be calculated in different ways. For example, it can be read from the profit and loss account. In simple terms, cash flow is the difference between company-related income and company-related expenditure within a specific period. The cash flow therefore says more about the financial strength of a company than the profit or capitalized earnings value. For example, when a company sells a product or service, this sale is recognized as a profit in the company. However, this does not mean that the customer has already paid. The cash flow therefore reflects the cash flow of a company. With the DCF method, the calculated cash flow, extrapolated for three planning years, is discounted to the current capital value and thus represents a company value.
Assessment: The DCF method was developed by auditors, is a purely future-oriented method and is mainly used for larger companies. The method appears to be less suitable for the purpose of valuing small and medium-sized companies, as the deviation from the capital market interest rate cannot be clearly calculated.
Assessment: The DCF method was developed by auditors, is a purely future-oriented method and is mainly used for larger companies. The method appears to be less suitable for the purpose of valuing small and medium-sized companies, as the deviation from the capital market interest rate cannot be clearly calculated.
Traditional net asset value method
In this method, the total assets of the company less its liabilities are determined. The value of the company is calculated on the basis of what a buyer would have to spend to reproduce the existing company.
In the first step, the assets necessary for the business (e.g. stock of goods, vehicle fleet, machinery) are valued individually on the basis of the inventory list. For this purpose, the individual items are assessed according to their replacement costs. The debts to be assumed are deducted from the value determined in this way. The result is the so-called partial replacement value.
The inventory list does not include intangible assets (e.g. patents, software) or goodwill (customer and supplier relationships, image, employee know-how). Therefore, the second step is to consider how the intangible assets and goodwill can be reconstructed. However, estimates are required to determine this, for which there are no recognized methods. If the intangible assets are added, the result is the full reproduction value.
In the first step, the assets necessary for the business (e.g. stock of goods, vehicle fleet, machinery) are valued individually on the basis of the inventory list. For this purpose, the individual items are assessed according to their replacement costs. The debts to be assumed are deducted from the value determined in this way. The result is the so-called partial replacement value.
The inventory list does not include intangible assets (e.g. patents, software) or goodwill (customer and supplier relationships, image, employee know-how). Therefore, the second step is to consider how the intangible assets and goodwill can be reconstructed. However, estimates are required to determine this, for which there are no recognized methods. If the intangible assets are added, the result is the full reproduction value.
Multiplier method (market value-oriented method)
In practice, there are different variants of the multiplier method. One variant is based on the operating result (profit before tax), whereby imputed costs, in particular the imputed entrepreneur's salary, must also be taken into account. Another multiplier, on the other hand, is based on turnover.
Ideally, in both variants, the average of the profit or turnover from a total of six financial years is formed: the last two financial years, the current year and the following three years. The result, the sustainable profit or turnover, is then multiplied by the corresponding industry factor.
Assessment: Working with multiples should be handled with caution, as each company has individual requirements and characteristics. General multiples can significantly distort the company value. As a rule, multiples have a lower value, which usually corresponds to the industry average, and an upper value, which serves as a guide for "successful companies". However, as these are industry multiples, the peculiarities of a relevant submarket are often not taken into account. Smaller companies in particular are characterized by a high degree of individuality, meaning that it can be difficult to assign them to the specified sectors.
Although the multiples method is quite easy to use, it reduces the complexity of the company valuation too much. However, it should not be overlooked as a benchmark in negotiations. Once the capitalized earnings value has been determined, the company value calculated using the multiplier method could be used as an additional argument to support the company's own position in purchase price negotiations.
Ideally, in both variants, the average of the profit or turnover from a total of six financial years is formed: the last two financial years, the current year and the following three years. The result, the sustainable profit or turnover, is then multiplied by the corresponding industry factor.
Assessment: Working with multiples should be handled with caution, as each company has individual requirements and characteristics. General multiples can significantly distort the company value. As a rule, multiples have a lower value, which usually corresponds to the industry average, and an upper value, which serves as a guide for "successful companies". However, as these are industry multiples, the peculiarities of a relevant submarket are often not taken into account. Smaller companies in particular are characterized by a high degree of individuality, meaning that it can be difficult to assign them to the specified sectors.
Although the multiples method is quite easy to use, it reduces the complexity of the company valuation too much. However, it should not be overlooked as a benchmark in negotiations. Once the capitalized earnings value has been determined, the company value calculated using the multiplier method could be used as an additional argument to support the company's own position in purchase price negotiations.
Liquidation procedure
The liquidation procedure involves the break-up of a company. The assets are valued according to the proceeds from the sale. All costs incurred are deducted from the proceeds of the sale. This result represents the absolute lower value limit.
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The special features of small and medium-sized enterprises
For small and medium-sized companies, it makes sense to carry out an adapted valuation procedure. There are special features that should be taken into account. For example, the role of the entrepreneur in small and medium-sized enterprises is of great importance. This special role is characterized, among other things, by the assumption of risk on one's own account, which implies the coincidence of ownership and company management. As a rule, the managing director is also the owner, which leads to different behavior than if a managing director with no financial interest in the company is employed.
Furthermore, uncertainty is the decisive problem that the entrepreneur has to deal with, which is therefore also important for the valuation of the company. The entrepreneur's willingness to take risks is constitutive for the creation and existence of the company. By often making decisions alone, the owner-entrepreneur shapes the corporate culture and strategy. If the owner/entrepreneur has poorly documented their knowledge and is unwilling to pass it on, this can lead to a decline in the value of the company. This shows that the company and the entrepreneur cannot be viewed separately.
A sale only makes sense if the company can survive without the entrepreneur. Consequently, two entrepreneurial personalities, that of the potential buyer and that of the potential seller, must be taken into account when valuing a company for the purchase or sale of small and medium-sized enterprises. In addition, the family of the owner-entrepreneur often provides the company with their labor free of charge.
In the case of small and medium-sized companies, planning often only exists in the owner's head. This makes it difficult to work with typical business management methods in a valuation. In the area of accounting, documentation often only meets the minimum legal standards. Cost accounting and controlling are usually carried out less formally than in large companies. In most cases, the focus is on one product. The fact that the owner-entrepreneur's own company is often the only financial investment complicates the assessment. Added to this is the high debt ratio, as many loans are taken out. For many small and medium-sized enterprises, it must also be taken into account that not only profit targets are pursued, but also other indirect and non-monetary targets.
It is clear to see that there are some special features that must always be included in the company valuation. Therefore, the valuation must be carried out thoroughly and in most cases external support must be sought.
Furthermore, uncertainty is the decisive problem that the entrepreneur has to deal with, which is therefore also important for the valuation of the company. The entrepreneur's willingness to take risks is constitutive for the creation and existence of the company. By often making decisions alone, the owner-entrepreneur shapes the corporate culture and strategy. If the owner/entrepreneur has poorly documented their knowledge and is unwilling to pass it on, this can lead to a decline in the value of the company. This shows that the company and the entrepreneur cannot be viewed separately.
A sale only makes sense if the company can survive without the entrepreneur. Consequently, two entrepreneurial personalities, that of the potential buyer and that of the potential seller, must be taken into account when valuing a company for the purchase or sale of small and medium-sized enterprises. In addition, the family of the owner-entrepreneur often provides the company with their labor free of charge.
In the case of small and medium-sized companies, planning often only exists in the owner's head. This makes it difficult to work with typical business management methods in a valuation. In the area of accounting, documentation often only meets the minimum legal standards. Cost accounting and controlling are usually carried out less formally than in large companies. In most cases, the focus is on one product. The fact that the owner-entrepreneur's own company is often the only financial investment complicates the assessment. Added to this is the high debt ratio, as many loans are taken out. For many small and medium-sized enterprises, it must also be taken into account that not only profit targets are pursued, but also other indirect and non-monetary targets.
It is clear to see that there are some special features that must always be included in the company valuation. Therefore, the valuation must be carried out thoroughly and in most cases external support must be sought.
Determine company value
The evaluation procedures
Special features for SMEs
Search for consultant
The search for a suitable consultant
In summary, company valuation depends on many factors and the choice of method cannot always be clearly determined.
Individual assistance in determining the value of a company is offered by tax consultants, management consultants and auditors, among others. It is often advisable to involve an advisory institution for a neutral valuation as a basis for negotiations between seller and buyer.
You can get in touch with the relevant experts, for example, via the Federal Association of Independent Consultants (https://www.kmu-berater.de/kmu-berater-finden) or the Federal Association of German Management Consultants (www.bdu.de). Publicly appointed and sworn experts for business valuations can be appointed by your regional Chamber of Industry and Commerce.
When selecting external consultants, both experience in valuations and knowledge of the market situation of companies in the sector are important. Under certain conditions, the consultancy costs can be subsidized by the federal government. Information on this can be obtained from the Federal Office of Economics and Export Control
(https://www.bafa.de/DE/Wirtschafts_Mittelstandsfoerderung/Beratung_Finanzierung/Unternehmensberatung/unternehmensberatung_node.html).
Individual assistance in determining the value of a company is offered by tax consultants, management consultants and auditors, among others. It is often advisable to involve an advisory institution for a neutral valuation as a basis for negotiations between seller and buyer.
You can get in touch with the relevant experts, for example, via the Federal Association of Independent Consultants (https://www.kmu-berater.de/kmu-berater-finden) or the Federal Association of German Management Consultants (www.bdu.de). Publicly appointed and sworn experts for business valuations can be appointed by your regional Chamber of Industry and Commerce.
When selecting external consultants, both experience in valuations and knowledge of the market situation of companies in the sector are important. Under certain conditions, the consultancy costs can be subsidized by the federal government. Information on this can be obtained from the Federal Office of Economics and Export Control
(https://www.bafa.de/DE/Wirtschafts_Mittelstandsfoerderung/Beratung_Finanzierung/Unternehmensberatung/unternehmensberatung_node.html).