Valuing Business
Enterprises, Business
Combination and Business
Failures
BY: Dan Mark del Prado
Maricon Mae Aviles Rose Ann Espanto
Daryll James Bulong Rachel Anne Pasion
Paulene Cambonga Shaina Marie Rafael
Joanne Coloma Grace Tajon
1. Valuation and the
New Company
1.1 Principles of Value
Following principles should be observe at the time of evaluating
a fair and reasonable value of property.
1. Cost depends upon supply and demand of the property.
2. Cost depends upon its design, specifications of the materials
used and its location.
3. Cost varies with the purpose for which valuation is done.
4. In valuation, a vender must be willing to sell and so the
purchaser willing to purchase.
5. Present and future use of any property should be given due
weightage in valuation.
6. Cost analysis must be based on statistical data as it may
sometimes require, evidence in a Court of law.
Value Classifications (spranger’s
classification)
• Theoretical value- mathematical value
worked out for the property.
• Economical value- is a measure of the
benefit that an economic actor can gain
from either a good or service and is
generally measure in terms of currency.
• Social and culture value
• Aesthetic value
• Religious value
1.2 Valuating the Company
• A business valuation is a general process of determining the
economic value of a whole business or company unit. Business
valuation can be used to determine the fair value of a business
for a variety of reasons, including sale value, establishing
partner ownership, taxation, and even divorce proceedings.
Owners will often turn to professional business evaluators for
an objective estimate of the value of the business.
• Business valuation is the general process
of determining the economic value of a
whole business or company unit.
• Business valuation can be used to
determine the fair value of a business
for a variety of reasons, including sale
value, establishing partner ownership,
taxation, and even divorce proceedings.
• Several methods of valuing a business
exist, such as looking at its market cap,
earnings multipliers, or book value,
among others
Special Considerations:
Methods of Valuation
There are numerous ways a
company can be valued. Here
are several of the methods.
1. Market Capitalization
Market capitalization is the simplest method
of business valuation. It is calculated by
multiplying the company’s share price by its
total number of shares outstanding. For
example, as of January 3, 2018, Microsoft
Inc. traded at $86.35. With a total number of
shares outstanding of 7.715 billion, the
company could then be valued at $86.35 x
7.715 billion = $666.19 billion.
2. Times Revenue Method
Under the times revenue business valuation
method, a stream of revenues generated
over a certain period of time is applied to a
multiplier which depends on the industry
and economic environment. For example, a
tech company may be valued at 3x revenue,
while a service firm may be valued at 0.5x
revenue.
3. Earnings Multiplier
Instead of the times revenue method, the
earnings multiplier may be used to get a more
accurate picture of the real value of a company,
since a company’s profits are a more reliable
indicator of its financial success than sales
revenue is. The earnings multiplier adjusts
future profits against cash flow that could be
invested at the current interest rate over the
same period of time. In other words, it adjusts
the current P/E ratio to account for current
interest rates.
4. Discounted Cash Flow (DCF) Method
This method of business valuation is similar
to the earnings multiplier. This method is
based on projections of future cash flows,
which are adjusted to get the current
market value of the company. The main
difference between the discounted cash
flow method and the profit multiplier
method is that it takes inflation into
consideration to calculate the present value.
5. Book Value
This is the value of shareholders’ equity of
a business as shown on the balance sheet
statement. The book value is derived by
subtracting the total liabilities of a
company from its total assets.
6. Liquidation Value
This is the net cash that a business will
receive if its assets were liquidated and
liabilities were paid off today.
2.Merger and
Consolidation
2.1 FORMS OF
BUSINESS
COMBINATION
2.1.1 HOLDING COMPANY
• Holding Companies
• The holding company is that which holds at least 51 percent
shares of other companies. Such other companies are known as
subsidiary companies. The subsidiary companies retain their
separate entities. The subsidiary company may be holding
company of another company. The holding company has more
control over the subsidiary companies in management and
decision making.
Holding Companies:
• Holding company is a more integrated
form of business combination whereby
control of several companies is vested in
one company through transfer of
ownership rights
• Holding company is a company which
acquires controlling interest through
transfer or direct purchase of shares in
other companies. Such other companies
are called subsidiary companies.
Types of Holding Companies:
a. Primary Holding Company:
• It is at the apex of a complex of different subsidiary
companies. It is not however a subsidiary of any other
company. In other words, it is not controlled by any other
company.
b. Parent Holding Company:
• It is an existing undertaking which seeks to consolidate other
competing units by organising subsidiaries.
c. Consolidated or Offspring Holding Company:
• It is a new company to which a group of existing
companies has proposed to transfer bulk of their
shares carrying controlling right in exchange of
shares allotted by the new company.
d. Intermediate Holding Company:
• It is a holding company of another but at the same
time it is a subsidiary of some other holding
company, i.e., it holds controlling interest in the
capital of some companies and its own shares are
held by some other holding company.
e. Pure Holding Company:
• Its main purpose is to invest in and control the affairs of the other
companies. Associated Cement Co. in India is an example.
f. Mixed Holding Company:
• It is engaged in some business operations and at the same time
holding majority of voting power in the share capital of other
companies.
g. Proprietary Holding Company:
• It is one which acquires whole of the share capital of the subsidiary
company or companies.
2.1.2 MERGER
• Merger
• In merger one independent firm takes over another independent
firm. The taken over firm losses its existence. The buyer firm
retains its entity and becomes stronger than previously. This type
of business combination is formed to eliminate growing
competition among merging firms. See the given below example.
• a+b=A
• The above example shows that ‘a’ firm purchased ‘b’ firm and ‘a’
becomes more stronger.
Merger:
In merger one company absorbs another
company or companies. The absorbing
company takes over the assets of the
absorbed company and often assumes its
liabilities. The identity of the absorbed
company is lost since its assets from the
property of the absorbing company. The
shareholders of the absorbed company are
compensated in the form of cash, shares in
the absorbing company, etc.
2.1.3 CONSOLIDATION
CONSOLIDATION:
Consolidation are of two types. They
are:
(A) Partial consolidation and
(B) Complete consolidation
A. PARTIAL CONSOLIDATION:
Partial consolidation means coming together
of firms under formalised common
ownership and control while retaining their
separate entity. Obviously their objective is
to avoid competition by integrated
management of the firms as one unit. We
study briefly three types of partial
consolidation, viz., Trusts, Holding
Companies and Community of Interests.
B. COMPLETE CONSOLIDATION:
Complete consolidation occurs when two
or more concerns combine to transfer their
assets and liabilities to a new company or
when one company absorbs another
concern by outright purchase of its
business. Complete consolidation thus
means end of separate identity of
constituent units and their amalgamation
into a single unit.
2.2 Terms of Combination
• Business Combination
• A transaction or other event in which an acquirer obtains control
of one or more businesses. Transactions sometimes referred to as
'true mergers' or 'mergers of equals' are also business
combinations as that term is used in [IFRS 3]
• Business
- An integrated set of activities and assets
that is capable of being conducted and
managed for the purpose of providing
goods or services to customers, generating
investment income (such as dividends or
interest) or generating other income from
ordinary activities*
• Acquisition Date
- The date on which the acquirer obtains
control of the acquiree.
• Acquirer
-The entity that obtains control of the
acquiree.
• Acquiree
- The business or businesses that the
acquirer obtains control of in a business
combination.
2.3 Methods of Avoiding Acquisition
• Poison Pill Defense
This defense is controversial, and
many countries have limited its
application. To execute a poison pill,
the targeted company dilutes its
shares in a way that the hostile
bidder cannot obtain a controlling
share without incurring massive
expenses.
A "flip-in" pill version allows the company
to issue preferred shares that only existing
shareholders may buy, diluting the hostile
bidder's potential purchase. "Flip-over"
pills allow existing shareholders to buy the
acquiring company's shares at a
significantly discounted price making the
takeover transaction more unattractive and
expensive
• Staggered Board Defense
A company might segregate its board
of directors into different groups and
only put a handful up for re-election
at any one meeting. This
staggers board changes over time,
making it very time-consuming for the
entire board to be voted out.
• White Knight Defense
If a board feels like it cannot reasonably
prevent a hostile takeover, it might
seek a friendlier firm to swoop in and buy
a controlling interest before the hostile
bidder. This is the white knight defense. If
desperate, the threatened board may sell
off key assets and reduce operations,
hoping to make the company less
attractive to the bidder
• Greenmail Defense
Greenmail refers to a targeted
repurchase, where a company buys a
certain amount of its own stock from
an individual investor, usually at a
substantial premium. These premiums
can be thought of as payments to a
potential acquirer to eliminate an
unfriendly takeover attempt.
• Stocks With Differential Voting Rights
A preemptive line of defense against a
hostile corporate takeover would be to
establish stock securities that have
differential voting rights (DVRs). Stocks with
this type of provision provide fewer voting
rights to shareholders. For example, holders
of these types of securities may need to
own 100 shares to be able to cast one vote.
• Establish an Employee Stock Ownership Plan
Another preemptive line of defense against a
hostile corporate takeover would be to establish
an employee stock ownership plan (ESOP). An
ESOP is a tax-qualified retirement plan that offers
tax savings to both the corporation and its
shareholders.7 By establishing an ESOP, employees
of the corporation hold ownership in the
company. In turn, this means that a greater
percentage of the company will likely be owned by
people that will vote in conjunction with the views
of the target company’s management rather than
with the interests of a potential acquirer.
3.Failure and
Reorganization
3.1 Common Causes of Business Failure
• Failure is a topic most of us would rather avoid. But ignoring
obvious (and subtle) warning signs of business trouble is a
surefire way to end up on the wrong side of business survival
statistics.
• Running an organization is no easy task. Being aware of
common downfalls in business can help you proactively avoid
them. It’s a constant challenge. We know, but it’s also a
continuous opportunity to avoid becoming one of the
statistics.
1.Failure to understand your market and
customers. We often ask our clients, “Where
will you play and how will you win?”. In
short, it’s vital to understand your
competitive market space and your
customers’ buying habits. Answering
questions about who your customers are
and how much they’re willing to spend is a
huge step in putting your best foot forward.
2.Opening a business in an industry
that isn’t profitable. Sometimes, even
the best ideas can’t be turned into a
high-profit business. It’s important to
choose an industry where you can
achieve sustained growth. We all
learned the dot-com lesson – to
survive, you must have positive cash
flow. It takes more than a good idea
and passion to stay in business.
3.Failure to understand and communicate what you
are selling. You must clearly define your value
proposition. What is the value I am providing to my
customer? Once you understand it, ask yourself if
you are communicating it effectively. Does your
market connect with what you are saying?
4.Inadequate financing. Businesses need cash flow
to float them through the sales cycles and the
natural ebb and flow of business. Running the bank
accounts dry is responsible for a good portion of
business failure. Cash is king, and many quickly find
that borrowing money from lenders can be difficult.
5.Reactive attitudes. Failure to anticipate or react
to competition, technology, or marketplace
changes can lead a business into the danger zone.
Staying innovative and aware will keep your
business competitive.
6.Overdependence on a single customer. If your
biggest customer walked out the door and never
returned, would your organization be ok? If that
answer is no, you might consider diversifying your
customer base a strategic objective in your
strategic plan.
7.No customer strategy. Be aware of how customers
influence your business. Are you in touch with
them? Do you know what they like or dislike about
you? Understanding your customer forwards and
backwards can play a big role in the development of
your strategy.
8.Not knowing when to say “No.” To serve your
customers well, you have to focus on quality,
delivery, follow-through, and follow-up. Going after
all the business you can get drains your cash and
actually reduces overall profitability. Sometimes it’s
okay to say no to projects or business so you can
focus on quality, not quantity.
9.Poor management. Management of a
business encompasses a number of
activities: planning, organizing, controlling,
directing and communicating. The cardinal
rule of small business management is to
know exactly where you stand at all times.
A common problem faced by successful
companies is growing beyond
management resources or skills.
10.No planning. As the saying goes, failing to
plan is planning to fail. If you don’t know
where you are going, you will never get
there. Having a comprehensive and
actionable strategy allows you to create
engagement, alignment, and ownership
within your organization. It’s a clear roadmap
that shows where you’ve been, where you
are, and where you’re going next.
3.2 Types of Business
Failures
1. Preventable failures
• These could have been foreseen but weren’t. This is the worst
kind of failure, and it usually occurs because an entrepreneur
didn’t follow best practices, didn’t have the right talent, or
didn’t pay attention to detail. If you’ve experienced a
preventable failure, it’s time to more deeply analyze the
effort’s weaknesses and stick to what works in future
ventures.
2. Unavoidable failures
• These often happen in complex
situations and involve unique sets of
factors. This is the type of failure
currently dogging energy firms beset by
an oil price collapse that almost no one
saw coming. The lesson from this type
of failure is to create systems to try to
spot small failures resulting from
complex factors, and take corrective
action before it snowballs and destroys
the company.
3. Intelligent failures
• These are the best kind. They happen
fast, and don’t consume too many
resources. This kind provides the most
useful information for the least cost.
This is the philosophy behind the trial-
and-error approach, in which a business
conducts experiments to find a product
or business model that works. The
lesson here is clear: If something works,
do more of it. If it doesn’t, go back to
the drawing board.
3.3 Strategies to Avoid Business
Failures
• Two big mistakes while developing your business plan can
cause your new business to fail: lack of research and lack of
preparedness. Avoid becoming a failed business by making
sure you don’t commit those mistakes and the following:
• Lack of a long-term company vision
• Failure to establish clear goals and
objectives
• Misunderstanding what customers
want
• Underestimating the competition
• Inadequate financial planning
• Lack of strong leadership
• Ineffective procedures and systems
• Absence of critical business skills
• Inability to change
• Failure to communicate the plan
7 Ways to Avoid Business Failure
• 1.) Behind every great company is a great leader. According to
McBean, great leaders know how to define their goals and
create a plan to direct their company to achieve those
objectives. Leaders should have a vision of what that strategy
is and how to put it into action. Employees tend to follow the
type of work habits, philosophy, and direction their business
leader practices.
2) Leaders should know the ins and outs.
Great leaders must know what every
employee does and understand their day-to-
day operations. A successful company needs
management that can look for ways to make
processes more efficient. McBean advises
business owners to point out improvements
and be clear about consequences when
employees deviate from policies and
procedures. If a business owner is not strict,
he/she will lose control of the company.
3) Money matters. The most important factor
in how to avoid business failure is protecting
the company’s financial assets. Businesses must
be aware of their investments and closely
maximize their profits. McBean warns if you
aren’t aware of your company’s investments,
they may unpleasantly surprise you and cause
you more hurt than gain.
4) Plan for the future. Business leaders
don’t have a crystal ball, but they can make
educated predictions and plans for action.
McBean gave the example of Ford Motor
Company. Before the financial downfall in
2008 and 2009, Ford restructured its debt
and raised funds in its cash reserves.
McBean says this thoughtful move saved its
skin during the meltdown.
5) Stay current and know your brand. Once
you’ve built a great product or service,
know how to market yourself. McBean
encourages new businesses to invest in a
solid marketing budget to ensure
consumers are aware of the product or
service. Take the time and energy to invest
your marketing funds into a strategy that
works for your target market.
6) Be competitive. A new business must
adopt the mentality that its success is
contingent on winning battles. You have
to fight to the top
if you want to succeed. If you don’t,
McBean warns, your competition will
beat you to the prize.
7) Focus on your principles. General
business practices apply to all industries.
Don’t get too narrow-minded about specific
fields and forget common sense. According
to McBean, business owners must
understand all aspects of the business. If
you’re not an expert in accounting, tax law,
finance, or management, it might be wise to
seek advisement. You don’t want to make
crucial mistakes in these areas.
3.4 Reorganizing the Business
Enterprise
• A reorganization is a significant and disruptive overhaul of a
troubled business intended to restore it to profitability. It may
include shutting down or selling divisions, replacing management,
cutting budgets, and laying off workers.
• A supervised reorganization is the focus of the Chapter 11
bankruptcy process, during which a company is required to submit a
plan for how it hopes to recover and repay some if not all of its
obligations.
• A court-supervised reorganization
is the focus of Chapter 11
bankruptcy, which aims to restore
a company to profitability and
enable it to pay its debts.
• A company in financial trouble but
not bankrupt may seek to revive
the business through a
reorganization.
• Reorganization means drastic changes to
the company's operations and
management and steep cuts in spending.
• To get the approval of a bankruptcy
judge, the reorganization plan must
include drastic steps to reduce costs and
increase revenue. If the plan is rejected or
is approved but does not succeed, the
company is forced into liquidation. Its
assets will be sold and distributed to its
creditors.
END
