Valuation and Modeling

Valuation and Modeling

How much is this company worth?

Or, What can we buy (or sell) it for?

The purpose of this section is to help a buyer (or seller) answer both questions. The first question is about value, which is general and abstract. The second question is about price, which is specific and concrete.

Some believe that the only thing that really matters is price. No matter that Lehman Brothers had $600 billion in assets when it sold to Barclays for only $250 million in cash and assumption of liabilities; price proponents would say that in the end, its worth was no more or less than $250 million. (To be sure, this happened back in the panicked market of 2008—the same market that enabled JP Morgan to buy Bear Stearns for $2 per share—but there are such fire sales even today, with the purchase of the UK branch of Silicon Valley bank and its debts for merely 1 £ total.) Nor would price proponents blink at the 219 percent premium Abbott Labs paid for Medical Optics when spending $2.8 billion on the company in 2009, or the $44 billion Facebook Elon Musk paid for Twitter in 2022, setting a record . The pricing school of thought shrugs at the discrepancy, rejecting any notion that Lehman, Bear Stearns, or Silicon Valley were undervalued, that Medical Optics or Twitter were overvalued: if the price is set honestly at arm’s length (with no fraud or self-interest involved), they believe that price is value, value is price.

Previous editions have noted that value essentially exists only in the minds of the people setting it, while price reflects real-world market behavior and is sometimes the only criterion we have available to estimate an asset’s intrinsic value. Yet while price is a tangible concept with a clear legal definition that can be a reality check against theory, it has its limits. It can only occur in a transaction setting within a contract. As such, it can never be enough. To hold price up as the be-all-and-end-all of value would be like saying that public companies are only worth their current stock price, when we all know how volatile stock prices can be—and how much more a buyer will pay for control in the form of a premium. So instead of mere pricing, the more enlightened members of the M&A community support the use and study of valuation based on theories developed in the academic and professional fields—and, equally as important, modeling, through which abstract concepts become actionable.

Valuation and modeling, as distinct from mere pricing, have great utility for buyers and sellers alike. In a depressed market, a reliable valuation and model combination can help sellers either hold out for a better buyer, or alternatively reinforce the price being offered from potential, albeit, bottom-feeding buyers. In a manic market, a professional valuation, supported by financial modeling, can either help buyers avoid caving into fads, or alternatively support a view that the time is right to sell. Despite a reliable valuation and model combination, the price ultimately any acquirer pays for a company represents and comes down to the outcome of a number and ultimately a final negotiation between what the buyer is willing to pay and what a seller is willing to accept—and behind that final price lie many valid considerations on both sides that do not cease to be true once the price is set.

Although price can be expressed as a single number—the $X that Company A paid for Company B—it is hardly a simple matter. The amount that might be paid for the same company may vary greatly among different buyers at different times. One might say that just as beauty lies in the eyes of the beholder, so too value lies in the equations of the buyer and seller. But which equations to use?

There is no limit to the possible approaches and methodologies one can take to valuation. There are more than a dozen in use. (See Exhibit 3-1) Which should you choose?

Of the models listed in Exhibit 3-1, two dominate: comparable companies and transactions, and discounted cash flow. The comparable companies approach is recognized in courts of law around the world when appraisals are challenged. And in at least the U.S., discounted cash flow is also often recognized as valid. Even so, it is not always easy to use either one, given the number of variables that need to be factored in, including some that are purely hypothetical. Fortunately, help is available. Investment bankers stand ready to produce fairness opinions to opine on a valuation of a public company transaction that might be challenged by shareholders. Appraisers have credentials to value even the most unusual assets—and they can avail themselves of global standards (as discussed at the end of this section). As for economic analysis, you don’t have to be a financial economist yourself to get this work done. Any accredited business school is likely to have a team of them ready, willing, and able to help—at an affordable price, or even pro bono.


Exhibit 3-1 Valuation Approaches and Methodologies



Value as function of:


Income Approach

Expected return it generates

Discounted Cash Flow (DCF)

Exit Value

Leveraged Buyout (LBO)

Venture Capital Method

Real Option Pricing

Economic Profit Approach

Net asset value and/or earnings that exceed the “normal” return on the assets

Economic Value Added (EVA)

Owner’s Investment Value

Probability-Weighted Expected Return

Market Approach

Comparison with comparable assets traded on the market

Comparable Companies

Comparable Transactions Enterprise Value

Net Asset Approach

Estimation of the assets (tangible and intangible) minus liabilities

Book Value

Carrying Value

Current Value

Net Asset Value

Replacement Value

Sunk Cost Value


Book Value (or Liquidation Value): The equity on the balance sheet (assets minus liabilities)

Carrying Value: The historic price paid for a company’s assets, adjusted for depreciation and amortization (how they are being carried on the books)

Comparable Companies: Using multiples or ratios to compare a company to peer companies

Comparable Transactions: Using multiples or ratios to compare a company to peer companies that have been purchased

Current Value: Calculating the value of a company’s assets at current prices rather than prices paid when purchased.

Discounted Cash Flow: Considering the net present value of the company’s future cash flows.

Economic Value Added: Not operating profits after tax (NOPAT) minus weighted average cost of capital (WACC) x capital invested, where capital invested is equity plus long-term debt.

Enterprise Value: Calculating market capitalization plus debt, minority interest, and preferred shares, minus total cash and cash equivalents

Exit Value: The amount of money that would be paid if original investors were repaid with a reasonable return on investment

Leveraged Buyout Value: Same as exit value but assuming repayment of bank loan

Net Asset Value: The equity on the balance sheet calculated with cash assets at fair value and cash liabilities at redemption value.

Owners’ Investment Value: Amount of money investors have paid for their shares. This may be adjusted for total shareholder return (TSR): (Current share price – share purchase price) + dividends} ÷ share purchase price

Probability-Weighted Expected Return: A projection of future returns calculated by assigning probabilities to various return scenarios and then adding them up.

Real Option Pricing: Valuing a company as if it were an option on the future.

Replacement Value: The amount of money it would take to replicated the company from scratch now

Sunk Cost Value: The amount of money owners have already spent to create the company

Venture Capital Method: Return on Investment (ROI) = Exit Value ÷ Postmoney Valuation. Conversely, Postmoney Valuation = Exit Value ÷ ROI. It is also typical to factor in the risk of early failure, and the need to retain capital (retention ratio).


But even before consulting a specialist, it is valuable to learn the basics. The purpose of this section is to explain how deal price comes about, and why.