The factors determining the value of a company

The value of a company can vary hugely depending on internal and external parameters, but also from the point of view of the parties concerned.

There may be several reasons for an assessment of a company's value: the purchase or sale of the company, the setup of a company by contributions in kind, a change of company status, the takeover of an interest, a merger, a split-off, a change of partner, the calculation of the statutory reserve for rightful heirs upon succession or conflicts affecting settlement of property between spouses. In the context of settlement of a succession, the valuation of the company helps prepare both the seller (what is the minimum price I can ask?) and the buyer (what is the maximum I am able to pay?) to make a decision. This is referred to as a final decision value or a cut-off value because it involves determining the limits of a possible compromise.

The calculated value can also serve as a pitch value during negotiations. It is also possible for both parties, particularly in the case of a family succession, to request a neutral expert assessment in order to determine a transactional price or a fair consideration value. This is referred to as an arbitration value.

The value of a company is not the same as its price

A distinction should be made between company value and price. As for any commodity, supply and demand decide price. The valuation of the company constitutes the basis for the calculation of the sale price or, in the case of a family succession, the takeover price. When negotiating an agreement, both parties are advised to start from a company value that is as realistic as possible.

There is no restrictive process for calculation of this price. In fact, there are a large number of methods which may produce different results. However, it is crucial to choose the method which, in each case, best corresponds to size and financial and wealth structure and which takes into account the line of business, and to then corroborate the result using another method.

During the ensuing negotiations, it is quite normal for both parties to assess the financial aspect from opposite points of view.

  • On one side, the entrepreneur handing over his or her business. The entrepreneur has a sentimental connection with the company; so he or she will favor a backward-looking valuation. In practice, we often see a tendency to overestimate the value of the company if the valuation is based on the resources invested, the time spent and efforts made or the introduction of a pension scheme.
  • On the other side, the successor. The successor assesses the situation rationally, looking for growth potential; at the end of the day, he or she wants to pay or be charged as little as possible.

Risks of overvaluation

In practice however, it is not unusual to find that the seller, and sometimes the seller’s advisor, does not know how to determine a realistic price for the company. In the event of overvaluation, there is a risk of creating expectations in the seller’s mind for succession negotiations, which make the search for a successor difficult or cause negotiations to fail.

If an agreement is nevertheless entered into with an excessive takeover price, the buyer may well presume too much about its financial capacity with, at the end of it all, the collapse of the company. Experience has shown that the risk of overvaluation is particularly high for very small companies in which the change of generation goes hand-in-hand with a complete change of internal organization (accounts, calculations, relations with customers and suppliers) or, depending on the circumstances, with organizational reconstruction following the takeover.

Factors external to the company that influence price

Of course, the value of the company is determined according to objective criteria, but other factors come into play in defining the price, including:

  • Influence of the personality of the current company director;
  • Change in turnover and profit;
  • Level of innovation of products or services;
  • Size of the company and independence of the internal organization;
  • Competitive environment;
  • Number of takeover offers and potential successors;
  • The successor’s age;
  • Financial and family situation of the current company director and of the successor;
  • The successor’s capacity to assume risk.

Value of the company in the case of family successions

In this case as well, an objective estimate of the value of the company needs to be made. By fixing the transactional price or the consideration price, it is necessary to consider the rights to the statutory reserve for rightful heirs or the compensation rights of the seller, as these depend on the market value of the company being transferred. If the company’s assets are transferred to the successor at below market value, inheritance or gift tax may well be levied, particularly in the case of transfers to unrelated members of the family or employees.

In practice, there are various methods, all more or less reliable, which give similar results if they are applied correctly – that is the theory in any case. In reality, we will find that estimates are very different and that the price actually obtained comes at the lower end of the range.

Last modification 03.05.2021

Top of page