Search

Financial models are widely used in a variety of business applications from financial reporting to capital budgeting to valuing and structuring mergers and acquisitions. The purpose of this chapter is to discuss the basics of applying financial modeling methods to firm valuation and to assist the reader in understanding the power (and limitations) of models in analyzing real-world situations. The model discussed in this chapter is relatively simple consisting of four Microsoft Excel worksheets and is applied to the valuation of a single firm.

In this chapter, the focus is on the application of financial modeling to value and structure mergers and acquisitions (M&As). A detailed discussion of how to construct M&A financial models is beyond the scope of this chapter. Rather, the intent of this chapter is to provide the reader with an appreciation of the general characteristics of such models, their data input requirements, and how they may be used to address questions relating to valuation, deal structuring, and financing. For example, models help an acquirer determine the implications of various possible deal structures before submitting an initial offer and in assessing the implications of various financing or postclosing capital structures (i.e., the composition of financing). Both acquirers and target firms can use models to evaluate rapidly alternative proposals and counterproposals likely to arise during the negotiation process. Models also help all parties to the transaction understand the key determinants of value and the relative contribution of each party to value creation. Such information is critical to each side in the negotiating process in determining an appropriate purchase price and distribution of risk.

This chapter addresses relative valuation (i.e., market-based) methods, asset-oriented methods, real options analysis (i.e., contingent claims), and replacement cost, often used as alternatives to discounted cash flow valuation. Relative valuation methods include comparable company, comparable transactions, comparable industry techniques, and value driver-based valuation. Asset-oriented methods include tangible book value and liquidation- or breakup valuation techniques. This chapter also discusses in detail how to look at merger and acquisition (M&A) valuation in the context of real options and concludes with a summary of the strengths and weaknesses of the alternative valuation methods (including discounted cash flow) and when it is appropriate to apply each methodology.

This chapter describes the various forms of cooperative domestic and international relationships common in business today, including joint ventures, partnerships, strategic alliances, equity partnerships, licensing agreements, and franchise alliances. The primary theme of this chapter is that well-constructed business alliances (both domestic and foreign) often represent viable alternatives to mergers and acquisitions, and they always should be considered one of the many options for achieving strategic business objectives. This chapter details the wide variety of motives for business alliances and the factors common to most successful alliances. Also addressed are the advantages and disadvantages of alternative legal structures, important deal structuring issues, the implications of the 2017 tax legislation, and empirical studies that purport to measure the contribution of business alliances to creating shareholder wealth.

This chapter begins with a discussion of common sources of merger and acquisition (M&A) financing. The role of private equity firms in financing highly leveraged transactions is discussed in detail. Highly leveraged transactions, typically referred to as leveraged buyouts (LBOs), are discussed in the context of a financing strategy. This chapter also describes the changing nature of LBOs, their impact on innovation, firm performance, and employment, as well as factors contributing to their success, typical capital structures, and the pitfalls of improperly structured LBOs.

The integration phase is an important contributor to the ultimate success of the merger or acquisition, and ineffective integration is commonly given as one of the primary reasons mergers and acquisitions (M&As) sometimes fail to meet expectations. This chapter outlines a practical process for realizing successful integration. The critical success factors include careful premerger planning, candid and continuous communication, adopting the right pace for combining the businesses, appointing an integration manager and team with clearly defined goals and lines of authority, and making the difficult decisions early in the process. This chapter concludes with a discussion of how to overcome some of the unique obstacles encountered in integrating business alliances.

This chapter focuses on the implications of tax and accounting considerations for the deal-structuring process. Tax considerations can affect the amount, timing, and composition of the purchase price. If a transaction is taxable, target shareholders typically demand a higher purchase price to offset the anticipated tax liability. The increase in the purchase price may cause the acquirer to defer some portion of the purchase price by altering the terms to include more debt or installment payments to maintain the same purchase price in present value terms. Moreover, the decision as to the appropriate organizational structure of the combined businesses is affected by such factors as the desire to minimize taxes and pass through losses to owners. The S corporation, LLC, and the partnership eliminate double-taxation problems. Current operating losses, loss carry forwards or carrybacks, or tax credits generated by the combined businesses can be passed through to the owners if the postclosing organization is a partnership or an LLC. With the elimination of pooling of interests as an alternative to purchase accounting in 2001 and further changes in financial reporting standards that took effect in late 2008, acquirers are likely to be more circumspect in making acquisitions. Overpayment for target firms and the use of contingent payout mechanisms can result in significant increases in future earnings volatility for acquiring firms. Furthermore, equity may become less attractive as a form of payment due to the requirement to record business combinations on the closing rather than the announcement date, although these concerns may be mitigated by the use of collar arrangements. The ever-present threat of these factors may exert some discipline into the negotiating process, affecting both the amount and timing of offer prices and the length and intensity of merger and acquition (M&A) due diligence.

This chapter discusses in detail the hazards of dealing with both limited and often unreliable data associated with private firms. This chapter then focuses on how to properly adjust questionable data as well as how to select the appropriate valuation methodology and discount or capitalization rate. Considerable time is spent discussing how to apply control premiums, minority discounts, and liquidity discounts in valuing businesses. This chapter also includes a discussion of how corporate shells created through reverse mergers, and leveraged employee stock ownership plans are used to acquire privately owned companies and how PIPE (private investment in public equity) financing may be used to fund their ongoing operations.

The corporate takeover has been dramatized in Hollywood as motivated by excessive greed, reviled in the press as a job destroyer, hailed as a means of dislodging incompetent management, and often heralded by shareholders as a source of windfall gains. The reality is that corporate takeovers may be a little of all of these things. The purpose of this chapter is to discuss the effectiveness of commonly used tactics to acquire a company and evaluate the effectiveness of various takeover defenses. The market in which such takeover tactics and defenses are employed is called the corporate takeover market, which serves two important functions in a free market economy. First, it facilitates the allocation of resources to sectors in which they can be used most efficiently. Second, it serves as a mechanism for disciplining underperforming corporate managers. By replacing such managers through hostile takeover attempts or proxy fights, the corporate takeover market can help to promote good corporate governance practices. This chapter defines corporate governance as factors internal and external to the firm, which interact to protect the rights of corporate stakeholders. Finally, case studies at the end of the chapter provide an excellent illustration of how takeover tactics are used in a hostile takeover to penetrate a firm's defenses.

This chapter focuses on the first two phases of the acquisition process—building the business and acquisition plans—and on tools commonly used to evaluate, display, and communicate information to key constituencies both inside (e.g., board of directors and management) and outside (e.g., lenders and stockholders) of the corporation.

The integration phase is an important contributor to the ultimate success of the merger or acquisition, and ineffective integration is commonly given as one of the primary reasons mergers and acquisitions sometimes fail to meet expectations. This chapter outlines a practical process for realizing successful integration. The critical success factors include careful premerger planning, candid and continuous communication, adopting the right pace for combining the businesses, appointing an integration manager and team with clearly defined goals and lines of authority, and making the difficult decisions early in the process. This chapter concludes with a discussion of how to overcome some of the unique obstacles encountered in integrating business alliances.

This chapter addresses relative valuation (i.e., market-based) methods, asset-oriented methods, real options analysis (i.e., contingent claims), and replacement cost, often used as alternatives to discounted cash flow valuation. Relative valuation methods include comparable company, comparable transactions, comparable industry techniques, and value driver-based valuation. Asset-oriented methods include tangible book value and liquidation- or breakup valuation techniques. This chapter also discusses in detail how to look at merger and acquisition (M&A) valuation in the context of real options and concludes with a summary of the strengths and weaknesses of the alternative valuation methods (including discounted cash flow) and when it is appropriate to apply each methodology.

This chapter describes the various forms of cooperative relationships common in business today, including joint ventures, partnerships, strategic alliances, equity partnerships, licensing agreements, and franchise alliances. The primary theme of this chapter is that well-constructed business alliances often represent viable alternatives to mergers and acquisitions, and they always should be considered one of the many options for achieving strategic business objectives. This chapter details the wide variety of motives for business alliances and the factors common to most successful alliances. Also addressed are the advantages and disadvantages of alternative legal structures, important deal-structuring issues, and empirical studies that purport to measure the contribution of business alliances to creating shareholder wealth.

This chapter begins with a brief review of rudimentary finance concepts, including measuring risk and return, the capital asset pricing model, and the effects of operating and financial leverage on risk and return. The cash flow definitions, free cash flow to equity (equity value) or to the firm (enterprise value), discussed in this chapter are used in valuation problems in subsequent chapters. This chapter concludes with an illustration of the commonly used enterprise method to value a firm’s operating and nonoperating assets and liabilities to determine equity value.