Credit unions: Valuation and M&A transactions

Whether it is the increasing number of credit union mergers, growing interest in acquisitions of community banks and branches, or even investments in fintechs by credit unions and CUSOs, understanding valuation, its processes and techniques, is crucial for successful growth and solid financial performance.

Detailed below are some of the key valuation process steps. They lead from foundational steps all the way ‘up to’ the value itself.

Standards of Value

Standards of value are defined by the valuation purpose. Typically, fair market value is required in valuations for tax purposes, while investment value is limited to potential merger, acquisition and minority investment situations.

Fair Market Value is the price at which ‘property’ would change hands between a hypothetical willing and able buyer and a seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. Investment Value ​is the value to a specific investor (or group of investors) based on their individual investment requirements and motivations.​

Both standards can be used by Credit Unions and CUSOs when performing valuation of M&A transactions or when attracting new capital. The investment value might be higher or lower than the fair market value due to different assumptions (e.g., estimates of future earnings, risk, tax status, synergies). Of note: for litigation and financial reporting purposes, transactions are frequently recorded at fair value.

The 3 Main Valuation Approaches

The Income Approach is determined by converting anticipated future benefits based, in part, on 3-5 years of historical financial data; Discounted Cash Flow most often utilized​

The Market Approach ​compares subject to ‘similar’ sold organizations or public stocks​

The Asset Approach​ uses the aggregate level of individual assets of the business less liabilities (not typically utilized in CUSO M&A)

There are several important factors that should be considered when selecting the appropriate valuation approach. They are the history/nature/stage of development of the organization; the type of assets and liabilities; capital structure; and the availability of reliable, comparable, and verifiable data.

The Income Approach is the most often utilized valuation approach, and more specifically the Discounted Cash Flow Method (DCF), as it best allows for the specific organization expectations. Application of the Income Approach typically includes:

• Comparative and financial ratios analysis and benchmarking to the industry ratios​
• Economic and industry analysis​
• Site visit and management interviews​
• Determining balance sheet and income statement adjustments through a normalization process to correctly encapsulate an ongoing enterprise value including non-recurring, non-operating, GAAP compliance items, and synergies ​
• Matching earning streams to appropriate discount rates​
• Application of appropriate entity level and ownership level discounts or premiums, e.g., due to lack of marketability or lack of control, key person, restrictive agreement, etc.​

The Market Approach, also known as “comparables,” referring to either deal comps or market comps.

“Comps” uses appropriate market-based multiples (“Public Comps” or similar recent “Deal Comps”) selected from comparable companies. Examples include level of earnings, cash flow, revenue, invested capital or other financial factors that represent future financial performance.

Comps is most applicable ​for valuing organizations that are currently profitable and expected to continue making a profit in the foreseeable future. ​The challenge of this approach is that it may underestimate the value of high growth organizations as it may not take into consideration all future growth. ​Its application for credit unions often comes in the situation of an established CUSO looking for additional capital if comparable multiples are available.

In Conclusion

Overall, the Income Approach utilizing the DCF method is the preferred method of valuing a relatively small, non-public company such as a fintech or an organization such as a CUSO. This is due to the fact that comp multiples may not be available for recent private transactions or similar publicly traded businesses may be hard to find due to difference in size, business models and other characteristics.

Co-author: Anna Kochkina