I started a series on the steps to take when you want to invest in a microfinance bank before the outbreak of Covid-19 pandemic. Now that the steam seems to wane, I shall continue the discussion. In my earlier edition, I had mentioned that there are seven steps to take when you decide to invest in the business of microfinance. The seven steps are: prospecting, due diligence, valuations, negotiation, regulation, legal and takeover. Having treated prospecting and due diligence, we shall now focus on Valuation as the third step in the acquisition process.
Valuation of a business involves the process and the set of procedures that a business seller or buyer can use to estimate the economic value of the interest to be sold or acquired in a business. It is usually used by financial market experts to arrive at the price they are willing to receive (as a seller) or pay (as a buyer) to consummate the transaction. All businesses, without exception follow the same principle for which the microfinance bank is no exception. Buying a MfB can be tricky and lead to serious loss of money if you do not understand the principles of valuation and the peculiarities of the sub sector. MfB is a service rendering firm and not a manufacturing or asset based organization, so a thorough understanding of the process taken to arrive at how much to pay is not only important but necessary. Many investors jump into sealing an Mfb acquisition only for them to realise that the worth of the business they have acquired is far less than what they have paid usually called the purchase consideration. Unless you are a financial expert, do not engage in the valuation of the MfB yourself.
When I was to float Rigo MfB, I had decided that my first choice was the brown field approach i.e. acquiring an existing license. As I reviewed several offers, I soon realized that the offers were not realistic so I then opted for a brand new license which saved me a lot of money. By the way I do all my valuations myself. Many MfBs are overpriced and if as an investor you do not apply tact, you will end up paying more than the actual worth of the business.
It is worthy of mention that valuation is not only restricted to when a business is to be bought or sold. It can be used when a current investor wants to exit and you want to decide the price to pay for his investment; when the business wants to issue shares; when two businesses wants to merge; when seeking funding from banks or potential investors; strategic planning or even during litigations.
The primary document required for this assignment is the Audited Financial Statement(AFS) where the Balance Sheet and the Profit and Loss account provides the most important input. The balance sheet shows you the total asset and liability amongst other details, of the MfB taken as at a particular day, while the profit and loss account also called the Income Statement shows the relationship between revenue and expenses. When revenue exceeds expenses, it becomes profit. Conversely it becomes a loss when expenses exceeds revenue.
Since a Mfb is a service based organization, the following tools are required for you to arrive at an adequate price. You may choose to use the Asset-Based approach, Earnings value approach or Market value approach. Each of these method has its unique characteristics. As an investor, I would usually use the three at the same time noting the highest and the lowest and further find the average of the results from the three methods. The outcome usually come handy during negotiations.
I will not want to bore you with the calculations and technicalities here but my next edition will try to simplify the approaches to enhance your comprehension and application.
See you next week.
Finance February 6, 2020