Value of Company

Value of Companies

After a career spent buying and selling companies, I’ve learned that the essence of a deal comes down to this simple fact:

A company is sold when its value is greater to the buyer than it is to the seller.

This obvious statement raises the more complex question: Why is the value of the same company different for the buyer and the seller? This can also be answered in a simple, though perhaps less obvious, statement:

Value is the future cash flows to the owner over time, discounted by the owner’s risk discount rate.

Now, this starts to get more complex. The values are different because the cash flows over time will be different for different owners, and because each owner has a different discount rate. In addition, the discount for the same owner will change over time.

Here are two examples from the owner’s perspective:

1. Think of a company owned by a relatively young person in his mid thirties. You don’t often hear of these owners selling their companies. Here’s why: for this owner, he expects to get a 30-year return of future cash flows. Plus, he will expect to grow those cash flows at a rate greater than inflation over the 30 years.Equally important, his discount rate for risk is low. His rate is low because he has a 30-year window to adjust and recover from the bad things that will happen along the way. He can weather a three-year recession and still be building value when the economy recovers. His health is good, so there is little risk that he will be forced to sell his company during a period of lower M&A valuations.

2. Now think of a company owned by a person in his sixties. His future income stream is really only three or five, or maybe seven years long. He cannot expect significant growth in that income stream in those few years. He is not prepared to make extra investment of time or money to accelerate growth. Even if he had an idea to stimulate growth, there is little time to implement it, it would have risk and the rewards...