Valuation
As the owner of a private company you can commission a valuation of your business at any time. For example a 409A valuation is an independent appraisal of the fair market value (FMV) of a private company’s common stock on the date of issuance. This valuation is based on guidance and standards established in section 409A of the IRS’s internal revenue code (IRC).
ESOPs require a valuation of the company’s shares to determine stock option awards or to determine value when an employee leaves or retires.
A valuation might be required in a divorce case to determine a fair allocation of the couple’s assets.
In most cases these valuations follow a classic set of rules. These include:
- DCF – The free cash flows for the next 5 to 10 years with discount rate applied to arrive at the Net Present Value today
- Net Asset Value – the balance sheet value of all fixed assets plus current assets less current liabilities less long term debt.
- Multiple of Revenue based on:
- Public company comparables
- Recent M&A deals
- Multiple of adjusted EBITDA based on:
- Public company comparables
- Recent M&A deals
Some challenges
DCF or discounted cash flow: Sounds like a great idea except if you ask a management team the likely forecast profits and cash flows for the next 12 months they might struggle, never mind the next 5 years to 10 years!
Net Asset Value: Of course, your balance sheet will present a net asset value of your business on any day of the month but could you realize that number if you had to liquidate?
Adjusted EBITDA: These calculations try to adjust for one off costs or credits or add backs. For example an exceptional cost might include an daughter’s horsebox, an unusually high level of entertainment, an above market rate salary, or a one off exceptional bad debt. An one-off credit might include a high insurance payout, PPP credits due to Covid, exceptional gain on the disposal of an asset.
But it is essential to realize that this valuation must not be confused with the value a strategic buyer might place on your business. A valuation no matter how clever does not reflect your saleability. There is so much more to it than that.
Saleability
Most entrepreneurs do not get what they deserve on exit. In fact 90% of businesses are not ready for primetime.
The starting point to getting what you deserve is to think differently. Stop looking through the lens of a seller. Start looking through the lens of a buyer. An acquirer builds a picture of an acquisition target by looking through a very personal lens. It’s a look at your business through the lens of someone who will be integrating your business into their group. Successful acquirers are asking questions to understand how you would fit. They have a well thought out rationale on why acquiring targets like you makes sense. Strategically the acquisition might fill a product void, a talent void, a geographical gap, a new technology capture, access to a new vertical market, access to a range of specific customers.
Successful acquirers understand acquisitions are for operators. If you can’t run your current business successfully through operational excellence and rigorous playbooks, why do you have the audacity to buy someone else!
Looking through a buyer’s lens can be brutal to the uninitiated.
Over the years we’ve scaled, bought and exited dozens of businesses. Here is our top 15 attributes a buyer will measure you by. Only if you score well on most of these, will an acquirer take the time to build a business case with a perceived value to support the acquisition.
Top 15 attributes Buyers Love
- You have a compelling story, the value to customers is clear and your brand is admired in the industry.
- The buyer’s research indicates that your peers see you as top 5 in the industry
- Market research confirms you have one of the highest margins in your industry
- Revenues & profits are growing at 25%
- No one customer accounts for more than 5% of sales
- Your strategic plan shows a 3 year horizon of a strong & high growth market
- Legacy products are a small part of your recent revenue and profits performance and new product innovation is healthy
- Subjectively they believe your top ten managers are world class
- Leading to their conclusion that the business is NOT dependent on the owner
- Research and surveys show staff moral and engagement are high
- Current year’s Profit & Loss performance and full year forecast demonstrates continued growth over previous years
- Business model produces a sustainable annuity stream of income
- Accounts audited annually by recognized accounting firm
- Legal contracts and filings are in good order
- Track record of producing significant EBITDA of $3m to $10m and growth is continuing
Valuation and Saleability are connected by two simple sentences.
Sellers aspire to price. Buyers perceive value.
Our playbooks will help you focus on the right stuff to create value and their free!
Ian is the CEO/founder of Boston based The Portfolio Partnership, a value creation team of operators. We help owners “build businesses buyers love to buy” by deploying our successful playbooks. It starts with Positioning/Branding. We seamlessly join your team to work on the right stuff.
As always if you found these insights useful, please share.
