EVER WONDERED HOW MUCH YOUR BUSINESS IS WORTH?
James Tuckerman, Editor-In-Chief, Anthill Magazine
I posed this question earlier this year when we offered to run a blog series on the ‘black art’ of business valuation.
Our readers responded with gushing enthusiasm. I responded with a trip to the hospital.
Unfortunately, a highly disruptive spinal injury thwarted our attempts to address this important topic.
Here’s what I initially proposed, way back in May…
“Over the next new few weeks, I plan to review five different aspects of valuing a private company. And, of course, I’ll be seeking your comments and observations along the way… Therefore, if you are interested in the value of your business, or if you are interested in the potential value of your business opportunity, read on. If you are an expert in this area, please join the conversation and help inform our readers.”
Of course, as history reveals, I never got around to publishing my second post.
Today is your chance to pick up where I left off.
As part of our Magazine 2.0 Experiment, I have two new propositions:
Firstly, I’m asking you (dear reader) to provide your ‘top tip’ on the topic of business valuation.
Simply leave a comment below, with your name and URL. The best will be published as part of a story on this topic in our Dec/Jan edition.
Secondly, if this is your area of expertise and if you have more to say than simply providing a tip, I’m inviting you to contribute an article topic (and, later, an article).
I’m interested in any aspect of business valuation that can be addressed in under 600 words (the average length of an Anthill article).
So… if you would like to provide a ‘tip’, simply leave your comment below. If you would like to suggest/contribute an article, please also leave us a comment below.
Here are some terms and topics to get you thinking…
Liquidity Event, Hurdle Rate, Pre-Money Value, Post-Money Value
Comparable Method of Valuation
Discounted Cashflow Method of Valuation
Profit Multiple Method of Valuation
Strategic Buyer Method of Valuation
If you have any further suggestions, please don’t be shy, as together we attempt to explore the ‘black art’ of business valuation.
Tags: business valuation, magazine 2.0
September 4th, 2008 at 10:04 am
I would be interested in learning more about valuations based on multiples of profit in small unlisted businesses often with key person issues,specifically:
- the different structural drivers of multiple (e.g. private company with key person dependency, private company with good business systems, public unlisted, public small-scale listed (NSX etc), public ASX listed, international listed public company) and an idea of the relevant compliance costs, incentive and arbitrage issues involved in this
e.g. a public company with a 10x multiple buying a private company with a 3x multiple and extracting arbitrage profit by increasing the aquisition’s effective multiple AND potentially making synergetic savings
- the different impact of Industry profit percentages (e.g. retail vs service - would you use revenue or profitability?)
- a business with no profit, but good revenues (hence the ‘opportunity’ to turn it around)
- the determination of what comprises profit in a business where the founder is also paying themselves a salary (many small businesses where profit is determined by minimising tax, rather than maximising value)
+ all the valuation of startups, but there’s plenty of that online
+ valuations at exit/shutdown events - e.g. selling a customer database, assets, business name/domain etc. instead of the whole business (particularly relevant if there are key person problems)
I don’t know enough about the above to write anything about it, but would be interested in hearing from those that do!
September 4th, 2008 at 11:16 am
I have recently done a course on business valuation but can still say that there are plenty of mysteries left.I am an accountant in practice and have found it quite useful to have a better feel for how businesses are likely to be valued.
Where the business has been operating for some time and has a track record it seems to me that the cash flow going forward simply has to be validated. This is detective work and one looks for all the reasons why it is not going to happen.
It is the start-ups however that cause the head-ache. It seems to me that you just simply have to pull figures out of the air.
This is the area I am interested in because it is critical to understanding the basis on which new capital injections are made. How much of the company do you get if you inject $xxxx?
I would be interested in learning more about this.
The other area that I am wrestling with is the structuring of deals. This is the question that must be considered following the valuation. In the e-commerce area for instance what are the nature of the deals that are being done? How do you structure a good deal?
How do you know its a good deal?
This is one of the practical uses of valuation.
September 4th, 2008 at 11:52 am
My understanding is that when considering the appropriate EBIT multiple to use (which seems to be the most popular back-of-the-envelope calculation), the multiple varies quite considerably by industry. For example, a pub versus an accounting practise.
I’d be very keen to know what the generally accepted multiples are by industry or category, as that would provide the means by which most of us could roughly benchmark our own businesses. Using the pub as an example, it is such a large industry, with so many businesses changing hands each year, so there must be an a generally accepted multiple.
Now that would be handy information to have!
September 4th, 2008 at 3:03 pm
I am a licensed business broker and have attended various courses on ‘business valuation’ and attended numerous seminars over the years in search of the ‘definitive’ answer to ‘How to value a business’. Bottom line is, it is not a pure science, and as such I have always without exception come away from these courses disillusioned & thinking ‘what have I learned’. There are so many factors which have an influence on what a business will ‘transact for’, many of those are not particularly linked to the overall performance of the business. I refer to the fact that a strategic purchase will attract a higher multiple of EBIT than a general purchase. Mostly, multiples achieved for larger enterprises are higher than those for smaller enterprises. Others relate their analysis to ROI ‘Return on Investment’ expectations from a purchaser. However, many other factors independently influence the value, such as proprietary products /brands, history of the business, established supply/ service contracts and many, many more factors. Some will relate to ‘plant & equipment’ (age etc) and others will influence the level of ‘goodwill’ one may attach to the business price. Ultimately, the business will transact for whatever the market dictates and whatever the vendor deems acceptable. This was the common thread identified throughout all the seminars & courses I have attended and that still applies every time a business is sold. Often ‘buyers’ apply formulae they have learnt from their own sources/course, (which can be a good guide) but to rely on that as a definitive (non-negotiable) value for a business. It is not that simple – every single business is different. They will soon be left wondering, time and time again why they have missed out and been ‘gazumped’ on the business they really wanted, and believed they were offering top dollar for. In conclusion it is better to consult with an agent/broker who has experience at the ‘coalface’ and knows what price levels are being achieved for the style of businesses they seek.
September 4th, 2008 at 3:18 pm
OPTION ONE: when you are not yet making profits try licking your finger and putting it into the wind.
SECOND OPTION: on a less serious note, is to get at least one bona fide offer for at least some equity.
I know that might sound dumb, but any offer gives you a valuation precedent which you can leverage from and get some price tension between investors/purchasers.
If you don’t have profits, and don’t have some offer & you really need the money - then you are not in an enviable situation. i.e. revert back to option one.
September 4th, 2008 at 4:40 pm
In respect to Phil’s question I have found a very good site for peer valuations by industry, country, region etc. Take a look at www.infinancials.com and explore their tool during a free use period.
On the subject of valuations, my experience is its all in the eye of the beholder.. Just make sure the beholder likes you, your business model, has money, has time and happens to have successfully run a business that can be enhanced by your offer.
Be professional in your approach, make sure that if you take on the numbers path (DCF)that the information is uncontestable. Then for certainty discount heavily. But as I once read from a wiser person, chase the customer first with all the passion you have, get your widget in market and give yourslef every chance to place a real value on your business. Good Luck, coz its a lot of fun aswell!
September 5th, 2008 at 8:44 am
My take on this after talking with the broking world and also with investors, VC’s and the like over the last 10 years it is pretty much a case of -
* raw profitability
* timing for the business and/or the buyer
* whats trendy
* leverage on both sides depending on fit
* etc etc
You could formulate a list of criteria and probably get some good estimation systems HOWEVER as long as humans are involved there is no exact science to it all. It also depends on how good the seller can talk up the prospects of the business and the buyers eye on what is substance and what is marketing.
Bottom line in my experience is that one should focus on getting a business profitable and meet the business plan goals and worry about the sale of the business (value of the business) when they are forced to, have reached an exit strategy point or someone comes along with a pot of cash.
September 5th, 2008 at 9:05 am
It seems we are all echoing the same concerns.
One problem with comparing with peer businesses ( regarding generally accepted multiples) is to find an appropriate peer business. If the business is listed that info may be available but with private business it can be really difficult to find enough for this exercise.
Validating with a business broker is a really sound move. I was aked to give an indicative value for a video shop recently and a broker was able to advise that the multiples had moved down recently and he gave me the ‘multiple’ range which allowed me to provide the client with a fairly reasonable idea as to what to expect.
As well the broker was able to advise regarding the special foibles ( regarding the replacement of video stock) in getting to the EBIT figure for the shop.
So it does mean that one necessary step in the process for providing valuations is to have the valuation perused by an independent person who has some experience in the market place with recent sales.
But sometimes it will be really difficult to find that person.
And this is really only applicable to existing businesses—–there is still the problem of start-ups and how to value them!
September 5th, 2008 at 9:44 am
In my experience (angel investing) the value of a business directly relates to ability of the people involved. How can we value what the individual people bring to the table? This is the human capital component if you like. The entrepreneur has created something that the investor didn’t, but the right investor can enhance the entrepreneur’s innovation. What they create together can be much greater than the ’sum of the parts’. Sure, they will reap rewards from profit, but how can the initial valuation be equitable? What seems to happen is that the value of money clouds the picture. Is money more valuable than innovation? Or is just that we can ‘see’ money? We seem to have a disproportionate amount of money to innovation in our society. Perhaps the right hand needs to get in touch with the left hand and ‘lift’ together.
September 23rd, 2008 at 11:34 am
The best advice I was given when I sold my first business was - look for the value beyond the numbers.
The real price is in the percieved value of owning the business to the prospective buyer. If you can work out what makes them tick & pitch at that, the price can go well beyond what a standard valuation would calculate.
October 5th, 2008 at 9:03 pm
I think all the answers listed above are correct in some situations. I disagree that valuation is not a “definitive process”, as it is based on the definition of the value of an asset - the net present value of future cash flows. The variations come about from different business models not always allowing simple cash flow calculations. Invariably easier forms of calculation of value are developed to both save time and also allow for different business models that provide different information.
The real “art” that is introduced into valuation is taking into account the “market desire” or the business. We all know that competition increases the value of anything on offer. So create competition for a business, and the natural “auction process” takes hold and before we know the desire for someone to have the business is greater than its theoretical value based on cash flows. Whether it was a correct decision to offer that price is actually another topic - that of the return on investment.
However the last word on return on investment, valuation and the desire for a business comes from the definition of the “indifference point” of a buyer. This is the price a person is willing to pay for a business and still be confident they will generate a sufficient return on investment. If the seller can get the buyer to their “indifference point” - then there is likely to be a significant premium paid for the business. The art is not in valuation - but in getting the buyer to see the real value and hence be willing to approach their indifference point.
As always, the art is in communication - the numbers will simply point the way.
October 9th, 2008 at 9:06 am
The best advice I have ever read and the best workshop I have ever been to in regard to valuing a business was in Brisbane with Tom McKaskill. Very smart man. If I learned nothing else, I learned the most important factor in valuing a business is to determine if you are seeking a financial buyer (about 90% of businesses) - or if you are seeking a strategic buyer (the other 10%). If you are seeking a financial buyer, then the EBIT model across different industries is fine - haggle your heart out. If you are an R&D company with few clients and a history for burning money, but a very clever idea - EBIT is your enemy. Seek out Tom McKaskill - The Ultimate Deal 1 & 2 and if you get a chance to attend his workshops, jump in both feet. Its worth it. He’s a very practical guy.
October 9th, 2008 at 9:43 am
We buy and sell businesses for a living, but are specialized in the ICT industry in Australia, particularly the second tier. In that context, we use many of the valuation methods people have alluded to here, but really keep in mind that the value of the business is only what someone is willing to pay for it. The valuation exercise is really only a predictor of the outcome of a sale process.
What I find particularly interesting is how much of an impact the sale process can have on the ultimate value of the deal. (And yes that’s completely self-serving.)
For instance, when we take an asset to market, we commonly talk pro-actively to a considerable number of potential counterparties, and get a variety of sale options (offers) onto the table. Often, about half of the fair offers received fall within the range of normal valuations from any of these calculation methods (and an honest view of what’s really for sale). Another 25% or so come at asset or breakup value, or are just lowball offers. Most financial investors pulled into one of these two categories.
The offers were really looking for though, are where people have a unique need for that asset, or unique use for it, and are willing to pay over the odds for for it. These are almost always strategic buyers, and more often than not come from a wholly unexpected perspective — and we only find them through casting a wide net and being proactive. The difference is commonly 30-50% or more, and the biggest impactors on this premium are the number of counterparties you work with, the effectiveness of the presentation (Information Memorandum and personal), and the strategic flexibility of the asset.
We spend a lot of time and energy educating people about the process we use for this, and I would certainly be interested to read and hear more about how others work in this space, and how valuation fits into that process. That said, we certainly take to heart the maxim that something is only worth what someone is willing to pay for it.
Cheers,
Paul Hauck
Paul.Hauck@ICTStrategicServices.com.au
October 9th, 2008 at 6:43 pm
The value of a business is usually determined by a traditional benchmark based on an organisation’s profit, times a multiple while taking into account industry considerations, goodwill and issues such as prevailing market conditions. However, companies that demonstrate processes to run a profitable business and strategies to continue to develop profitable growth, are increasing the valuation of their organisations considerably.
While the focus traditionally is on increasing profitability to add value to the business, it should also be on developing a business where capital assets, such as goodwill are recognised and valued and consequently multiples are enhanced and potential valuations increased. If businesses can demonstrate that recognised business valuation layers - from clients, staff and systems, down to product extensions, distribution channels, brand/position and scale - have been built into their business, then they will be able to demonstrate underlying business assets and sell their own shareholdings for potentially much greater sums.
Richard Erickson
Shirlaws Business Coaching
PS I’m happy to contribute an article regarding these seven layers of business valuation