Five Common Adjustments in Corporate Valuations

Sarah Martin

30 years: Corporate Valuations

In this video, Sarah Martin explores various adjustments that may be needed to refine initial business valuations, particularly in the context of mergers and acquisitions (M&A) involving private companies. It covers adjustments for net working capital, certain liabilities, specific assets, and dilutive instruments, as well as the rare case of contingent consideration. The video emphasises how these adjustments can lead to more accurate and refined valuations in negotiated transactions.

M&A

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Five Common Adjustments in Corporate Valuations

9 mins 49 secs

Key learning objectives:

Understand the common types of valuation adjustments in M&A transactions
Identify how net working capital and certain liabilities can impact an initial valuation
Identify how specific assets and dilutive instruments necessitate valuation adjustments
Outline the circumstances under which contingent consideration might be used in a valuation

Overview:

Accurate business valuation often requires adjustments beyond initial figures, especially in negotiated M&A deals for non-listed companies. Key adjustments include those for net working capital (e.g., seasonal fluctuations or obsolete inventory), specific liabilities (e.g., outstanding taxes, related party debts, pension deficits), certain assets (e.g., non-earning land, joint venture shares), and dilutive instruments (e.g., employee stock options). Additionally, rare contingent considerations can be agreed upon based on future performance. These adjustments ensure a more precise and reflective valuation, enabling buyers and sellers to agree on a fair price.

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Summary

What are the primary types of valuation adjustments and when are they necessary?

There are five main types of adjustments: net working capital, certain liabilities, certain assets, dilutive instruments, and contingent consideration (though the last is quite rare).

These adjustments are typically made to the initial enterprise or equity valuation.These adjustments are most common in negotiated acquisitions, particularly when dealing with non-listed or private companies.

For listed companies, it's assumed that potential adjustments are already reflected in the share price, unless the company is distressed or in default.

How does net working capital affect valuation adjustments?

In M&A transactions, buyers and sellers often negotiate price adjustments related to net working capital. If a firm's inventories and receivables are seasonally low at the time of acquisition, or if there are issues like obsolete inventory or uncollectable receivables, the initial valuation may be reduced.

What types of liabilities might require a valuation adjustment?

Beyond net debt, various non-operational liabilities can lead to adjustments in the equity value. Examples include money owed to related parties, outstanding amounts to equipment suppliers, unfavorable property leases, provisions for restructuring costs or lawsuits, and pension deficits. Buyers may seek a reduction in the valuation or an indemnity for future losses stemming from these liabilities.

How can certain assets lead to valuation adjustments?

If an acquired firm possesses assets whose returns are not reflected in the initial valuation metrics (like EBITDA), their value should be added. Examples include unearning land that could be sold, financial assets, or joint venture shares.

What are dilutive instruments and how do they impact valuation?

Dilutive instruments, such as convertible bonds and employee stock options, give third parties the right to buy company shares. If these options can be exercised at a price below market value, the new owner may suffer a loss due to insufficient cash contribution to offset their dilution. Buyers may choose to buy out these instruments to ensure 100% ownership, adding this cost to the valuation.

What is contingent consideration in the context of valuation adjustments?

Contingent consideration involves additional payments from the corporate acquirer to selling shareholders based on future performance, contract wins, or drug approvals. This is typically negotiated to bridge valuation gaps when future outcomes (e.g., drug approval) are uncertain but would significantly impact the target firm's earnings and valuation.

Subscribe to watch

Access this and all of the content on our platform by signing up for a 7-day free trial.

Sarah Martin

Sarah Martin has a degree in economics from the London School of Economics and stock exchange and regulatory qualifications from London and New York. She has worked in investment banking for 17 years, as well as private equity transactions and as an expert witness in financial trials. She became a financial trainer 15 years ago and specialises in credit, distressed debt, and valuation. Recent assignments have included the European Central Bank, the European Investment Bank, the EBRD, Gibbs Business School in Johannesburg, the Bahrain Institute of Business Finance, the Bank of China, BBVA, the African Development Bank, Siemens, Carnegie Bank, Rand Merchant Bank, the Hamburg Central Bank, and Mizuho Bank.

There are no available Videos from "Sarah Martin"