Framing a Valuation Inside a Transaction: Four Questions

Framing a valuation inside a transaction means answering four questions in order: which number, struck as at when, on which earnings, and what the documents then do to it before money moves. The valuation itself arrives already made. The frame does not rebuild it and does not check it. The frame records what the price becomes, and names the basis of every figure it reports.

What is the frame doing that the valuation did not?

A number lands on the analyst's desk. Rs 1,320 crore, for Sundarban Polymers Private Limited. Somebody has already chosen a method, assembled a peer set, argued about a rate and settled on ten times earnings before interest, tax, depreciation and amortisation (EBITDA). The method, the peer set and the rate belong to the valuation material, where they are available to anybody who wants them, and repeating them is the single most common way a transaction summary wastes its opening.

FramingRecording what a number is, when it speaks for, what it rests on and what an agreement then does to it, without touching the work that produced the number in the first place. that number means saying four things about it. Which figure it is and what it is a value of. Which day it speaks for. Which earnings sit underneath it. And what the agreement then does to it between that day and the day money actually leaves the buyer. The frame does not rebuild the valuation and does not audit it; it records what the number becomes.

An ordinary question about an ordinary purchase shows why this matters. Somebody asks what a flat is worth. There are three honest answers and they are all different: the price on the board, the price once the outstanding society dues are settled at handover, and the price if the covered parking slot is bought as well. Nobody in that conversation is lying to anybody. All three speakers are answering different questions that sound like one question, and the only way through is to name which one is meant before the number is said.

Harivansh Packaging Limited buying Sundarban Polymers Private Limited has exactly that shape and a wider spread. Rs 1,320 crore, Rs 1,137 crore and Rs 1,197 crore are all correct figures about the same purchase. So are Rs 1,140 crore, Rs 1,332 crore and Rs 1,392 crore. Every one of them is in the agreement, every one is recomputed below, and a summary that reports one of them without saying which quantity it is has answered nothing while looking as though it answered everything.

What is the procedure, in order?

Seven steps. The seven steps run in this order on any purchase of any size, and the order carries weight rather than decoration. Two of the steps decide what the later steps are even allowed to compute. A correct arithmetic result attached to the wrong question is the most durable kind of error. The error survives every check that only looks at the sums.

1. Sourcing the number rather than rebuilding itRecord in one line where the valuation came from, then move on. The method is settled elsewhere and pointed at, never restated.
   Checking: is the method one pointing line rather than a section?
2. Naming which number is being framedThe figure, its unit, and what it is a value of. Written down before any comparison is attempted.
   Checking: could a reader tell whether this is a value of the whole business or of what the sellers receive?
3. Date the number, and name the other daysThe day it was struck, the day the agreement was signed, and the day money moved.
   Checking: does every figure in the frame carry the day it belongs to?
4. Name the earnings figure underneath itIts period, its basis, and any condition attached to it.
   Checking: does a second candidate earnings figure exist, and has it been named?
5. Apply what the documents doThe bridge first, then each completion adjustment computed on its own, then any conditional amount.
   Checking: has every adjustment been computed separately rather than netted before it was seen?
6. Report every correct multiple in one sentenceThe multiple in use with its two bases named, and the other one beside it with its own.
   Checking: does each multiple in that sentence say which figure sits above the line and which below?
7. Reconciling, then naming what remains unsettledThe amount paid and the amount assumed must reproduce the figure the multiple was struck on.
   Checking: does the frame tie, and does it name what it did not test?

Steps two and three are the ones people skip because they look like clerical work. Steps two and three are the reason the rest of the frame means anything. A figure without a stated quantity and a stated day is not a small carelessness. No other figure can ever be compared with it again. Six months later, somebody putting this purchase beside another one has nothing to work with except the agreement itself. Rebuilding the figure from the agreement is precisely what the frame exists to prevent.

Which number is being framed?

Step two sounds trivial and is where most confusion starts. Say the number, say its unit, say what it is a value of. Three clauses. Harivansh Packaging Limited and Sundarban Polymers Private Limited between them produce six correct answers to a single question about the worth of the business. The figures give the reader no help. All six look like money and all six are in crore.

Look at the spread. The smallest and the largest are Rs 255 crore apart on a purchase of this size, and neither is a mistake. Rs 1,320 crore is a value of the whole business including the borrowings that travel with it. Rs 1,137 crore is the cash that reached the sellers. And maximum considerationThe largest amount the sellers can end up receiving once every conditional payment in the agreement has been earned, whether or not any of it is ever paid. of Rs 1,197 crore is a ceiling that may never be reached at all, because it depends on something the target has not yet done.

Enterprise value is therefore never quoted as the price paid. The figure is a value of the business as a whole, and the sellers of an unlisted company are handing over the shares, not the borrowings. Say enterprise value and the reader thinks of the whole thing. Say equity value and the reader thinks of the cheque. Say the price and the reader has no idea which one was meant. Most transaction reporting leaves people in exactly that state.

As at what date was the number struck?

A valuation speaks for one day. One day is not a technicality about paperwork but the whole of what a valuation is: a statement about a business as it stood on a particular morning, using information available on that morning. Move the day and the borrowings, the working capital, the order book and the earnings the number was struck against all move with it. The as-at dateThe single day a valuation speaks for. Everything in the figure describes the business as it stood on that day, using what was known then, and nothing about any other day. is therefore part of the number rather than a label attached to it afterwards.

A transaction has at least three days that matter, and they can all be different. The day the number was struck. The day the agreement was signed. The day money moved. Somebody selling a scooter knows this instinctively: the price is agreed on Sunday, the money changes hands on Wednesday, and the fuel left in the tank on Wednesday is nobody's idea of a valuation question until it is time to hand over the key.

In this purchase two of the three roles fall on one day. Rs 1,320 crore was struck on the signing day, using the last full year Sundarban Polymers had reported. The completion day is later, and the completion adjustments are measured on it rather than on the day the number was struck. Two of the three days coinciding is a fact about this transaction and not a rule. The frame therefore records all three roles rather than assuming any two of them collapse.

Where the record stops is worth naming plainly. The record of this purchase carries no calendar dates. The agreement fixes them and the agreement is where they are read. The frame requires that the three roles are named and that every figure in it is attached to one of them.

On which earnings does the number rest?

Every multiple has a denominatorThe figure sitting below the line in a multiple. Ten times something is meaningless until the something is named, given a period and given a basis., and a denominator is never just a number. A denominator has a period, it has a basis, and in a purchase with a conditional payment it sometimes has a condition attached as well. Ten times what, earned when, measured how. Three questions again, and the answers are short.

A caterer quotes a wedding at a price per plate. Per plate on the count booked, or per plate on the count that actually sat down? Both are ordinary ways to quote, both produce a per-plate figure, and the two figures are not the same. Nobody argues about the arithmetic afterwards. The argument is about which count was underneath the figure, and a fight about the denominator is never a fight about the division.

The Rs 1,320 crore rests on Rs 132 crore, the EBITDA Sundarban Polymers reported for its last full year, on the reported basisThe earnings figure exactly as the business published it, with no normalisation, add-back or adjustment applied by anybody afterwards. with nothing added back and nothing normalised. Rs 1,320 crore over Rs 132 crore is ten times exactly. The headline multiple comes from that one division, and one line is deliberately all the frame gives it.

Then the second candidate appears. The agreement attaches a further Rs 60 crore if Sundarban Polymers reaches Rs 145 crore of EBITDA in the first year after completion. Rs 145 crore sits 9.8 per cent above the Rs 132 crore it earned. The Rs 145 crore level is a conditional denominatorAn earnings figure a payment depends on. It belongs to a future period, and it becomes a second legitimate figure to quote a multiple against without ever having been the one the valuation used.: a real figure, in the agreement, belonging to a period that has not happened. A purchase with a conditional payment carries at least two candidate denominators, and choosing one of them silently is how a price gets reported as cheaper than any honest reading of it.

What do the documents do to the number?

The fifth step exists only because the documents come after the price, and it is the whole reason the frame is worth having. The number struck in the valuation is not the number that moves. The difference between them is defined in the agreement rather than in the analysis, and no amount of re-reading the valuation will produce it.

Three things happen to Rs 1,320 crore. The bridge takes off the net debt the transaction assumed, Rs 180 crore, leaving equity value of Rs 1,140 crore. The completion adjustments then move it twice: working capital at completion is Rs 108 crore against a peg of Rs 96 crore, so Rs 12 crore is added, and net debt at completion is Rs 195 crore against Rs 180 crore assumed, so Rs 15 crore comes off. And the earn-out sits above all of it as a conditional Rs 60 crore.

The two completion adjustments come to plus Rs 12 crore and minus Rs 15 crore, a net of minus Rs 3 crore on Rs 1,140 crore. Look at how small that net is, and then look at what produced it. A buyer who checked only one of the two would have been wrong by Rs 12 crore or by Rs 15 crore rather than by Rs 3 crore, so the smallness of the net is exactly why both are computed and never a reason to skip either. Netting first and inspecting afterwards is a different procedure with a different failure mode, and it is not this one.

How is a multiple reported when more than one is correct?

The purchase now has three enterprise values and two candidate earnings figures. Six arithmetically correct multiples come out of them. Not six opinions. Six divisions, every one of them sound, spread across a range from 9.10 times to 10.55 times. A range of nearly a turn and a half, on one purchase, with no dispute about any of the inputs.

The rule that handles this is double reportingWhere more than one multiple is correct for the same purchase, naming the one in use with both its bases and naming the other one beside it in the same sentence.: where more than one multiple is correct, the one in use is reported and the other named in the same sentence. Not in a footnote, not in the appendix, not in a separate table further on. The two figures only protect the reader when they arrive together, so they belong in the same sentence.

Written out for this purchase it reads like this. Harivansh Packaging Limited is paying 10.09 times the Rs 132 crore Sundarban Polymers earned, on an enterprise value at completion of Rs 1,332 crore, and 9.60 times the Rs 145 crore the earn-out turns on if the maximum enterprise value of Rs 1,392 crore is paid. Twelve words longer than the alternative and impossible to misread. Reporting only one of two correct multiples without saying which is the commonest fault in transaction summaries, and it is a reporting fault rather than a mistake in any sum.

Does the completed frame tie back?

The last step closes the loop. The amount that reached the sellers, plus the net debt the buyer actually assumed at completion, should land on the enterprise value the completion multiple was struck against. Rs 1,137 crore plus Rs 195 crore is Rs 1,332 crore. The Rs 1,332 crore in the grid above is the same figure arrived at from the other end, and it did not have to agree.

Look at the two failures underneath. Both are sound arithmetic. Rs 1,137 crore plus Rs 180 crore is genuinely Rs 1,317 crore, and Rs 1,140 crore plus Rs 195 crore is genuinely Rs 1,335 crore. The addition was never wrong in either case, so neither of them ties and neither can be fixed by checking the sum. Each one has taken a figure from the wrong day: the first uses the net debt assumed at signing where the net debt measured at completion belongs, and the second uses the equity value before the adjustments were applied.

Catching a figure from the wrong day is the job of the tie-backThe closing check on a frame: the amount paid plus the amount of borrowing assumed must reproduce the figure the multiple was struck on, or one of the framing answers is wrong., and the check belongs at the end rather than beside the working. The reconciliation is the output of the frame rather than a check on it. A frame that does not tie has one of its four answers wrong, and the arithmetic does not identify which one. The failed tie shows only that the four answers do not describe a single consistent purchase, and that is enough to send the analyst back to the agreement with a short list.

What does the finished frame look like set out in full?

The finished frame is shorter than anybody expects, and the shortness is the point. Four answers, one double-reported multiple and one reconciliation line. Everything Devyani Kulkarni, chief financial officer of Harivansh Packaging Limited, needs in front of her before a board discussion, and everything Ashwin Rege needs on the file so that the next reader does not reconstruct it from the agreement.

What will the frame not do?

The frame carries two refusals, and a reader who does not know the limits of a tool will use it past them. The frame will not say whether the valuation was well done. And it will not say whether the price was right.

The first is out because it belongs to the work that produced the number. Whether ten times was the right multiple, whether the peer set was well chosen, whether a rate was well estimated: all of that is testable, and all of it is tested in the material that produced the figure rather than in the material that records what happened to it. A frame that starts auditing the valuation has reached into somebody else's work and left its own undone.

The second is out for a harder reason. No figure in this transaction settles it. Whether Harivansh Packaging Limited paid the right amount for Sundarban Polymers Private Limited depends on what that money would otherwise have done and on what the combined business goes on to achieve, and neither of those appears anywhere in the agreement, the accounts or the frame. The arithmetic is checkable and the merit is not, and the strongest honest statement a completed frame can make is that its figures reconcile.