What’s My Business Worth?
Most business owners have a view on the value of their business – maybe you’ve run a DCF, analyzed the comparable transactions. It might be even simpler – you just have a price where you’d be willing to move on.
Valuation. We could be talking about anything from “book value” to “fair value” to “market value” or perhaps even a section 409(a) tax valuation. So let’s simplify things by asking a more direct question: What is my business worth if I want to sell it?
The answer is strikingly simple. Ready for it?
Your business is worth what someone will pay to buy it. If there’s no buyer at the price you set – no matter how you come up with that price – your business is not worth that price.
But how do you know what a buyer will pay?
Absent a line of buyers calling you up or knocking on the front door to make you an offer, the best way to estimate the value of your business is to run one or more traditional valuation methodologies, such as Trading Comparables, Precedent Transaction Analysis, or a Discounted Cash Flow model. (There are others, but to keep this digestible, we’ll focus on these three because they are arguably the most common).
Traditional valuation methodologies are incredibly important to help value your business, but they are a GUIDE, not a verdict. All of these approaches are widely used and have different pros and cons, strengths and weaknesses. But all of them are THEORETICAL, and they lack sufficient CONTEXT. They all rely on assumptions and estimates, and require perspective on things like the future of the business, market dynamics, the competition, buyer behavior, economic cycles, and many other subjective elements. Every business is different, and every situation is different.
If you can consider how a buyer might interpret these same methodologies when they are looking at your business, you’re getting even more useful context. Layer in the appropriate context and comparisons when using traditional valuation methodologies, and you can start to home in on a valuation that might, um, have some value.
So let’s examine three traditional valuation methodologies:
Trading Comparables
Precedent Transactions
DCFs (at a high level).
1. Trading Comparables.
Let’s say your closest competitor is a public company trading at 8x EBITDA. How do you determine if your company is worth 8x, or more or less? Consider how you compare to the comps to use them as a valuation benchmark.
- Are you growing faster or slower than your competitor? Generally, higher growth companies are higher-valued. Growing faster?
- Are your margins higher or lower? Do you generate more or less cash?
- How do you compare in terms of scale, revenue, profit, employees, brand etc.?
- Do you have more or fewer patents than them?
- How does your customer base compare to your competitors? Are they spending more or less on your products?
There’s a no shortage of additional questions we could list out here – this is just a starting point for the discussion.
2. Precedent Transactions or Acquisition Comparables.
The questions above generally also hold for precedent transactions or acquisition comparables. However, in this context, you can also layer in some questions related to the deal environment now and then, because the deal environment is relevant:
- How long ago did the comparable deals close?
- What’s changed in the market since the comparable deals? (For example: A software company sold in late 2001, when the Tech Bubble had burst, probably did not get as strong a multiple as a similar software company in 2019, when the M&A market was setting volume and value records and software companies were in very high demand from all types of buyers.)
- What was the market environment at the time of a given deal – was the market in the early stages or final stages of consolidation (i.e. are the a lot of buyers left after the deal?)
- For a given transaction – did the buyer have a unique need that only that target filled?
Hopefully the point is coming across. You need to objectively compare your business to your peers and to relevant benchmark transactions to figure out whether the multiple should be the same, higher, or lower.
3. DCF.
Unlike other valuation methodologies, which look to market benchmarks to estimate valuation, a DCF is highly theoretical and heavily rooted in assumptions and estimates of future performance. With a DCF or other similar NPV-oriented business value model, it’s important to carefully scrutinize the projections and assumptions in the model. Are they reasonable? Conservative or optimistic? Are the projections achievable or best-case? And maybe most importantly, what estimates, assumptions and projections will a buyer use when running a DCF on your business from the other side? That’s before we even raise the question of perpetuity growth method or terminal multiple method.
Obviously valuation can be pretty subjective. Many investment bankers will tell you that valuation is at least part art. No matter which framework(s) you use to estimate the value of your business, remember that prospective buyers will also do their own work to determine what price they are willing to pay to invest in or acquire your business. By doing your own analysis, and as we like to advise, putting yourself in the buyer’s shoes, you can shrink the gap between your price and theirs – and at the same time arm yourself with the talking points and data to help them see your perspective.
The value of your business may be what a buyer is willing to pay – but if you use valuation methodologies to do some introspection you’re more likely to arrive at a similar number.
Bonus tracks:
1). Is there a “best” valuation methodology to use?
In the context of selling a business, valuation is part art, part math – it’s subjective. For that reason, we recommend using a combination of approaches when possible - Look for validation and confirmation amongst the data. In some situations, trading comps may be more relevant – maybe the comps closely resemble your business. Maybe there isn’t a good set of precedent transactions to analyze, but you have a good model to populate a DCF. Looking at other methodologies for validation and to perform a bit of a sanity-check can be very helpful.
2). What are some landmines to think about? What can the traditional valuation methodologies miss?
The traditional valuation methodologies do well in analyzing the financials – what’s visible about the business. But selling a business is ultimately an exercise in risk management – expect the buyer to analyze risk elements not present on the balance sheet. Things like contingent or potential liabilities are great examples. These can include things like open and pending litigation against the seller, perceived IT security holes or flaws – things that can change the financial profile outside of market and competitive dynamics. Numerous times we have seen buyers walk away from deals when the risk is too great, or even just more unquantifiable. Know what’s on your balance sheet, but also what isn’t to limit surprises.
At Amplify Consulting Services, we are here to help you think about the hard questions – our objective is to ensure you’re prepared when it’s time to consider a transaction. If you’re considering your future plans for your company, let us help you work through it.
We offer hands-on transaction support throughout the planning, prep and process, and will roll up our sleeves to work with you at every step, in addition to coaching through webinars and seminars. Reach out and let’s discuss your objectives and how we can help you achieve them. Visit our website at www.amplify-cs.com or get the conversation started by reaching out at info@amplify-cs.com