Author: the Hon. Christopher S. Sontchi
There are a variety of methodologies to determine the value of assets that are routinely presented to bankruptcy courts: (i) asset-based valuation, (ii) discounted cash flow or “DCF” valuation, and (iii) relative valuation approaches, which include the “comparable company analysis” and the “comparable transaction analysis.”
This article explains in layman’s terms each of the methodologies and how they are used to reach a conclusion as to value. An asset based valuation generally calculates the liquidation value of individual assets and aggregates them to arrive at a firm value. DCF valuation calculates the value of any asset from the present value of expected future cash flows from it, which, in turn, rests on the proposition that a dollar today is worth more than a dollar tomorrow. Relative valuation involves the pricing of comparable assets, standardized using a common variable such as earnings, cash flows, book value, or revenues. The conclusion rests on the selection of the valuation metric, e.g., EBITDA, and the similarity of the companies or transactions used. The conclusions from each of the methodologies are generally blended to arrive at a conclusion of value.
The article closes by noting that bankruptcy judges have become familiar and comfortable with the DCF, comparable companies and comparable transactions methodologies, which are often referred to as the “standard” methodologies. Departures from the standard methodologies or how they are calculated must be explained to the judge.
This article was published in the American Bankruptcy Institute Law Review (20 Am. Bankr. Inst. L. Rev. 1 (2012)) and is available online here.