There are many different ways to determine the value of a company during an M&A transaction. Most of the time, the purchasing price is based on some sort of multiple (such as Firm Value /). But what is a company's real ? Let's assume that the buyer's decides to evaluate the target at 7 times its . In order to accomplish a low transaction price, the buyer normally hires financial advisors from the transaction advisory department of a big4 company. Their role is to adjust the target's and to calculate a normalized .
Many privately held companies are run by their owner(s). In order to overstate the company'sand to inflate the valuation, the management may pay themselves a salary below market levels, thus understating personnel expenses and overstating . The financial advisor would assume an more appropriate salary for the management by pushing up the salary to market levels until the target's reflects the underlying business reality of the firm.
Another way to inflate a company'swould be to spin off (non-core) business units and to book the profits as other operating income. Since profits from spinning of business units do not belong to the company's core operating activities but inflate the company's , financial advisors would also exclude such profits from the company's .
Many companies are organized in a holding structure andout multiple intercompany transactions. Let's assume you have a group that is comprised of 2 companies. One company is responsible for managing the administrative part (the holding company) of the business and the other one is actually carrying out the operational parts of the business. In order to optimize their tax burden, both companies may want to report a neutral net income. (This really depends on the applicable tax laws)
But what happens when the operating company is not profitable but the holding company is? In order to "balance out" their net income with each other, the operating company can charge a management fee for providing all kind of recourses for the other company. In reality it is really difficult to proof if the reason for those management fees and the amounts charged are justified.
Management fees increase the net income (andif it is booked as costs of material or administrative costs) of the operating company and decrease the results of the holding company. In case the buyer only wants to acquire the operating company, the financial advisor would subtract management fees received from the holding company from the company's .
There are quite some ways to inflate a company'sin order to increase the purchasing price during an M&A transaction. Since there are far more ways to inflate (such as increased revenue recognition, locked box vs. completion accounts and so on), I would appreciate additions /corrections from my fellow monkeys! How would you inflate of your start up in order to achieve a high valuation and to buy yourself your own island after selling your company?