Objectively valuing your business is an arduous task for any entrepreneur. Whereas valuators see a functioning business, you see a brainchild that had you awake for sleepless nights years-on-end to get to this point. Valuations are a tricky feature of business, and an ability to understand valuations can be the difference between rapid success and going on in a stasis.
The importance of valuing your company (objectively)
The objective of building your own business is to make significant material changes in the development your wealth-basket. The nuts and bolts are that even though dividends and other annuity income (eg: salaries) keep you going, the best (and most profitable way) of making a return on your business is through selling your company to a high bidder aka exiting.
Exits is are hinged on the valuation the sellers and the potential bidders can settle on. Whereas perceived value and goodwill play a strong role in the eyes of the entrepreneur, those intangibles must match the financials presented to provide a conclusive, slam-dunk story which can see you gain full realizable value for your hard work.
Discounted Cash Flows:
This method is used to estimate the value of an investment by presenting a net present value (“NPV”) of expected future cash flows using a discount rate (“R”). NPV is the investment amount drawdown, which is invested, R is the rate of return / interest rate expected during the investment lifetime. DCF is calculated as below:
|(CF/(1+R)^1) + (CF/(1+R)^2) …|
|Type of company:||Cash-landen / cash-generating business|
|Pros:||Close to actual intrinsic value of proposed business|
|Cons:||Great sensitivity to discount rate assumptions|
Net Asset Value:
This method calculates the total value of a business’ asset minus the total value of a business’ liabilities. NAV is calculated as below:
|Assets – Liabilities|
|Type of company:||Asset-landen company / large capital expenditure reliant business|
|Pros:||Adjustments can favour the asset holder|
|Cons:||Does not consider future earnings growth potential|
This method reflects risk attached to future earnings growth potential by using a company’s earnings before interest, depreciation and amortisation (known as Free Cash Flow) to assumes the enterprise value of the business. Earning multiples are calculated as below:
Multiple of 4
(Net income + Interest Expense + Tax + Depreciation + Amortisation) * 4x
|Type of company:||Company with high current and future earnings potential|
|Pros:||Adjustment of multiple can increase valuation dramatically|
|Cons:||Multiple is a discretionary value needed to be agreed by seller and buyer|
Whether it’s for that sweet early retirement package in the Bahamas, or needing to raise additional funding, inevitably you will need to assign a value your business. The more knowledge you have on the various valuation methods, the more ammunition you have to accrue greater value for your sleepless nights.