Bridging the Gap Between Numbers and Narrative in the Valuation Process
July 31, 2020
There are business valuation firms that simply input a client’s financial statements into a model and print out the results. SC&H is not one of those firms. Lindsay Baublitz, Vice President, SC&H Capital’s Business Valuation team, believes the firm’s real differentiator is their ability to tell a company’s story throughout their valuation reports.
Anyone can type numbers into a spreadsheet. It takes a seasoned valuation professional to bridge the gap between numbers and the narrative.
We recently interviewed Lindsay to highlight a few key elements that have led to SC&H’s valuations standing out in the marketplace.
Q: What is it about our firm’s valuation process that sets us apart from other valuation firms?
Certain steps are set forth by the American Institute of Certified Public Accountants (AICPA) and American Society of Appraisers (ASA) that all accredited appraisers must follow; therefore, we are always compliant with all of those.
Where we really differentiate ourselves is our ability to understand a company’s story – where it has been and where it is going – and make it the basis of our valuation analysis.
We put a lot of effort into the information-gathering phase. In addition to the standard financial documents we request, we also interview the management team to understand the reasons for fluctuations in financial performance and future prospects. Our valuation models are designed to quantify all of the drivers of value. Each element of the company’s story is incorporated into our assumptions (i.e., selected long-term growth rate, projected cash flows, risk assessment) and the selected valuation methodologies.
Our ability to weave the financial analysis together with the company’s narrative is what sets us apart.
Q: How do you structure the management interviews to gain enough insight into the business?
We do not just ask a standard list of check-the-box questions. We prefer to review preliminary financial information before speaking with management teams to utilize insights gathered from reviewing these reports to develop a tailored list of questions to guide our discussion. During our conversations with executives, we do not dive too deep into the numbers as we prioritize those questions for a CFO. Our main goal when we get to gather information from management teams is to get a sense of the key strengths of the business, as well as the challenges the company faces.
While we have access to the management team, we can glean additional information about the historical performance of the company and its projected growth. Examples of key details include:
- Non-recurring expenses hit the P&L that do not truly reflect the ongoing profitability
- Changes in the executive management team
- Shifts in the strategic vision of the company that may promote future growth
- Budgetary process changes, which may explain year-over-year variances
This type of information typically only comes out during our diligence discussion and is extremely valuable as we piece together our valuation analysis.
Q: How does our firm incorporate management’s insight into valuation reports?
A good valuation should bridge the gap between number crunching and storytelling. Throughout our valuation process, we piece together the narrative that we project unfolding for the company in the future. We consider the company’s history, people, and products, as well as the current economic environment, industry, and competitive pressures. Management’s insight is crucial to this process as they know their business better than anyone.
Personally, I hand-write notes during management discussions. Some of my notes are incorporated into our SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis, and other notes are used in the report to explain historical or projected changes in financial performance. I have been known to highlight my notes as I feel they have been captured in the report until all my note pages are solid yellow.
Q: Are there any parts of our analysis process in which we are more critical than others?
We spend a lot of time vetting management’s projections – they can have a huge impact on our conclusion of value – as we want to make sure we understand who was involved in making the projections and the process that was followed to create them. If the company has historically prepared budgets or long-term projections, we want to know to analyze them compared to the company’s actual performance.
While management has the most insight into the future of the business, we need to scrutinize the assumptions they have incorporated into the forecast. We analyze projected revenue growth rates compared to historical growth rates, contract backlog, and the pipeline of new work. We compare gross profit margins and EBITDA margins against historical margins and any industry pricing changes. If we think the projections are too aggressive, we may even make adjustments before relying upon them in our DCF model.
Q: SC&H has many clients who get an updated valuation each year, particularly ESOP clients. Do you approach these recurring valuations differently than a stand-alone project?
No, our process is the same. However, recurring valuations allow us to learn more and dive deeper each year. Every year, the company’s story changes – there may be changes in the industry, macroeconomic environment, shifts in predominant service lines or products, turnover in management, or unexpected global pandemics. The narrative in our report aligns with any shifts in value drivers, whether internal or external.
Q: How has access to investment banking professionals, and services SC&H Group provides supported the valuation team’s process?
SC&H Capital’s breadth of M&A expertise, services, and relationships arms our valuation team with an understanding of value drivers for both buyers and sellers in a variety of industries. Because we are frequently tasked with calculating Fair Market Value (the price at which a company changes hands between a willing buyer and a willing seller), our insight into the motivations of both buyers and sellers helps us support our concluded values. Many times, we are valuing a company that is in an industry where we just completed a transaction, so we have in-depth knowledge of the terms of the deal (purchase price, financing, multiples paid, earnouts, etc.).
As part of a larger accounting and management consulting firm, we have access to tax and audit experts who can help us understand the impacts of new tax regulations and accounting rules on our valuations. When the Tax Cuts and Jobs Act (TCJA) was passed, we leveraged our corporate tax department to ensure that our valuations were compliant with current tax guidance. When FASB’s lease accounting standard changed (ASU 2016-02, Leases Topic 842), we had several conversations with our audit department to understand the impacts on the financial statements and how we had to make changes in our valuation analysis.