What is My Company Worth?
Roy A. Ackerman, Ph.D., E.A.
I have been participating in a
discussion with members about the valuation of new entities over the past weeks. Clearly, there is no hard and fast rule to
this process- and, that’s mostly because we have no hard and fast ability to
determine who is going to succeed in the long term. It’s a little easier to
evaluate a going business, as long as we don’t try to discern how much the
future will impact the value of the company right now.
In the 80’s and 90’s, business valuations
were (relatively) high. Today, we have
lowered expectations and significant nervousness about our future (why no one
seems to worry about the present scares me more J). We still need to determine the valuation of
our companies - even if we don’t plan to go public. We need to determine the value of investing in
new equipment, obtaining a bank loan, or hiring new people.
But, those are not the only
reasons. What happens if a partner dies
or desires (forced?) to leave the business invoking a buy-sell clause. Or, even more
common today, the divorce of one the key principals of the
business requires the valuation to be determined. Other reasons include estate planning or the
desire or need to spin off a small (or large) portion of the business, due to
the changing vision of the firm’s future. As you can see, the need for business
valuation can be outside or inside driven and some have significant legal
consequences.
Since 2000, the valuation process
has shifted somewhat. Around the start
of the 21st century, one could assume that the price to EBIDTA
ranged from 3.5 to 9.5. (9.5 for revenue > $ 1 billion, 6.5 for > $100 million,
5 for > $ 20 million, and 3.5 for > $ 500K.) Part of this valuation change has been a
shift in circumstances doesn’t really affect the smaller enterprises: the
valuations were determined fromLinkedIn
the acquisitions
of companies- and those acquisitions were made for combinations of cash and
stock. As the cash portion for the
acquisition rose, the multiples dropped.
One can expect that trend to continue.
If you are
planning to sell your business, then you should consider paying a professional
to provide you with the valuation- either as ammunition to bargain for the best
price or assurance that your price is proper.
Seek out the services of an ASA (Accredited Senior Appraiser), CBA
(Certified Business Appraiser); the choice of a ABV
(Accredited in Business Valuation for CPA’s) or CVA (Certified Valuation
Analyst) is a lower-value choice. A
valuation runs from $ 4000 to $10000 (or more)- but
never accept one that would based upon the company’s value.
Keep in mind
that this method of valuation of your firm is a function of the depth of your
management team, the compensation package (it should be in line with industry
peers), the diversity of customers (more than two or three upon which the
company may rely), and the diversity of your suppliers (one key supplier’s
failure can shut you down). To command a
premium, your firm needs excellent cash flow.
The goal of the acquiring entity is the minimization of risk. The acquirer is buying the potential to make
money in the future- and the more they can make, the more they will pay.
No matter how
which metric (or metrics) upon which you base the valuation, the multiple (or
augmentation) that
your company may deserve compared to your
peers is always up for discussion.
The tools required to determine the valuation of your enterprise are
cash flow, earnings and assets. More
importantly, if you are not planning to go public, you should decide on a given
set metrics and
routinely use them. Using this valuation
helps you determine if you are meeting your objectives (and, in the case of
buy-sell or divorce, proves prior agreement to the terms and issues).
Here in a nut shell are the various valuation metrics.
Book Value: This old (and probably outdated) method is
the one your bank loves to use, but really has little utility. In this method, you determine your assets
(cash, equipment, buildings, receivables, etc.) and your liabilities &
debt. Subtract the latter from the
former and you have your book value. This
method does not take into account that you have depreciated your assets, the
replacement cost for equivalent assets, intellectual property, and the
like. The book value will almost always
provide the lowest valuation for an enterprise.
(In other words, it’s the one that many people argue to employ in
divorce cases.)
Liquidation value:
Almost as old as book value, this methodology fails as a results of the method’s assumptions. Receivables are typically valued (discounted) at 70 to 80 cents
on the dollar and inventory at 50 to 60 cents.
To us, this method only makes sense if one must determine what the
company needs to do during a reorganization (i.e., filing for bankruptcy and then
re-emerging from that shelter).
Excess Earnings: A somewhat newer concept, this
determines the value of the business’ tangible assets. Using a return on equity value (ROE, which
changes with time, based upon the prevailing economic conditions), one
determines what the earnings of the firm should be. The difference between that value and the
earnings of the firm are termed its “excess earnings”. Using the same ROE, one then capitalizes
these excess earnings, and then adds that value to the value of the assets of
the firm. [Please note that this method
NEVER works for consulting or professional firms. These firms deal more with intellectual
assets that cannot be properly valued; it would not be atypical for them to
have returns on equity of 2500 to 9000%.
Also, firms that lease their equipment (whether because they lack the
cash or because they decide to do so).]
Discounted Cash Flow. DCF is what the Wall Street analysts
use to assign value to companies.. And, as an undergraduate ChemE,
it was the method I had to learn- since the big petrochemical giants employed DCF
to make decisions about projects, products, and capital improvements. The basis for DCF is the cash flow of the
firm (not its assets)- especially future cash flows
(which means if one prognosticates badly, “GIGO”), including margins, debt, taxes, and
cost structures.
Comparative Value: If you are in the real estate market (or own
a home), you understand this methodology.
Just like one looks for similar home sale prices in comparable
neighborhoods and then applies that value to the home in question, one would do
the same for private companies. And,
herein lies the problem. Real estate sales are public. Private company sales are generally
private. Obtaining this information is
really difficult- and may not be reliable.
(For example, we would never divulge the pricing that any of our clients
obtained. Neither would most other
consultants. Only when the firm is
acquired by a public entity (and, even then, it would have to be a substantial acquisition
to be reported) or if there were bank/equity financing can the numbers be
reliably obtained.) [Further note: When Coca Cola acquired 40% of Honest Tea in
February 2008- no information was made public (of which we are aware), nor were
the “numbers” included in its 10K filing, other than a quick note 22 to its
2008 10-K; it now owns 100% and the numbers are still hidden.]
Hybrid Models: These models are the favorites of
back-of-envelope or napkin scribblers everywhere. One takes profits- and sales or earnings (one
or te other); obtains public
companies’ multiples (price/sales [P/S] or earnings/share) and determine the valuationyou’re your firm from these multiples. Some folks think they use a more refined
version when they employ the multiples for private companies in similar
industries. But, these results are
highly volatile and not valid for long term planning and comparison. Your profits and sales may not reflect
long-term conditions, and the stock market itself has volatility (ya’ think?). As
such, this method works best during periods of stability and when profit/sales ratio
is stable or predictable.
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