Ugly Maths?

July 26, 2023

What to do when the maths does not make sense in a valuation

Did you know that there are some situations where the calculations used to prepare a valuation are quite simply… unsafe?

Of course, it’s tempting to think that the numbers always give the right answers, but this is not always the case.

Sometimes the actuality of the transaction proposed is the route to finding the valuation answer.

Examples of when the numbers may not work include when there is significant volumes of debt in the business combined with a waterfall involving different share classes with preferential terms or where there is a lot of intangible IP.

When it’s a valuation for tax purposes you have to consider the valuation from the perspective of a prudent investor.

So if you are valuing a company where the investors are sophisticated and high levels of risk appetite are they being prudent in the context of their knowledge of the situation.

Clues will come in the deal structure.

If there is a high coupon on the debt and a high yield on the preferred stock, that would suggest that the investors are being prudent in terms of the route they are choosing to get their capital back versus any return they may be hoping for from their ordinary equity investment.

Another scenario where the maths might not add up in the first pass, is when there are a number of probable outcomes regarding the medium and long-term future of the company.

In this situation, it is necessary to undertake some probability analysis.

Whilst Monte Carlo valuations can act as a surrogate, it does not always do the job. It may be more accurate to look at the probability of the various scenarios arising and then weight the results so that you can adjust the valuation accordingly.

This is one of the many reasons why DIY valuations using online tools or a back of an envelope valuation, can be dangerous.

If there is ANYTHING about the company or the transaction that is not vanilla, there is a strong chance that the numbers will not give the full answer or maybe downright wrong.

You need a valuer who will look in the box, under and around it, in these situations.

We find these tricky valuations particularly interesting and we work fast when they are needed. Indeed it’s not unusual for us to get a call from a lawyer who has seen a report prepared by a generalist which does not add up, but the deal is just about to close so a solution must be found FAST.

If you have something on your desk where the current valuation does not pass your test, perhaps we could help?

We can produce a report in around 5 days and always produce the highest quality independent valuation with the understanding that our work must aid rapid closing, not raise more issues.