Subjective approach to microfinance valuation

IHAVE RECEIVED MORE COMMENTS on my valuation piece than any of my previous articles. Of interest is the fact that many people sought to know the outcome of the sample valuation exercises I mentioned. Whether the deals went through or not. The various comments unearthed the other side of valuation. The side I call “subjective” where you are required to follow your guts and ignore the figures.

When you value a business, a microfinance banks inclusive, the result of the valuation exercise becomes an indication of the worth of the business. This is objective! It is the empirical factors that forms the basis of the eventual decision you take. In my last edition, I mentioned 3 scenarios where the figures did not look good and I advised against the consummation of the deal but with a caveat which says “if you are so passionate about it”. This statement is laden with subjectivity defying and ignoring the essence of the empirical approach. This does insinuate, however that buyers should engage in subjective means when they want to acquire a business. You cannot substitute a professional valuation.

Subjective acquisition describes a situation where the buyer of a business bases his decision to pay a certain amount that is inconsistent with available empirical data for the business on personal feelings, taste or opinions. It is derived from the subjective theory of value which advances the idea that the value of a good is not determined by the amount of labour necessary to produce it but instead value is determined by the importance the individual places on a good for the achievement of his desired ends. Some people call it the “gut feelings”.

Let me share this valuation story that I recently concluded. A company in the Financial sector was up for sale. The interested buyer called me in to help verify the true value of the company and advise on what he should pay. The total asset of the target was about N2.5bn while their liability stock was about N1.1bn. Using the net asset approach, it was easy to say that the company was worth N1.4bn. Ahead of my conclusion, the buyer went ahead to make an offer of N1.8bn. This means that there is a premium of about N0.4bn that the buyer was willing to pay to acquire the business. I advised the buyer to be cautious in his approach and for those who would like to know if the deal went through, it did, because the buyer was willing to take the risk by setting aside, the result of the valuation exercise.

So it is not in all cases that the figures would count. What could therefore make a buyer jettison the advice of an expert?

1. If there are other competing offers such that the position of the buyer becomes threatened.

2. If the buyer sees more value beyond the figures and this happens sometimes.

3. If the buyer realises that he can strip the balance sheet and quickly recover the excess or premium or offer paid.

4. If the business is complementary and critical to the survival of his existing business. This can easily occur when a business is acquired for backward integration of for the purposes of forming a Conglomerate or Group or Holden structure.

For the purpose of easy comprehension, backward integration is a form of vertical integration in which a company expands its role to fulfill tasks formerly completed by businesses up the supply chain. In other words, backward integration is when a company buys another company that supplies the products or services needed for production. A microfinance bank can decide to acquire a card producing company to ensure they control the cost of production, their efficiency in delivery and quality or acquire a payment platform provider that will aid their efficiency payments.

I will conclude this series on valuation by affirming the importance to obtain the right basis before you make an offer and that the final decision to buy the business rest with the buyer and not the professional valuer.

See you next week.