by Moira Vetter, Forbes Contributor
Anytime you begin discussing entrepreneurship and finance, the topic turns to valuation. Determining what your company is worth, is not unlike determining what your child is worth. (Your kid is priceless, your company isn’t…although it’s no less personal.) To the owner, the process of valuation is subjective and emotional. To the buyer, the valuation process is far more objective.
The issue of valuation comes up regularly because it matters for several reasons. Let’s take a look at how finding a reputable advisor to help you determine your value is important in these instances:
- Valuation when you are seeking investors or capital
- Valuation when you are seeking to bring in partners or share equity with key employees
- Valuation when you are seeking to sell
Valuation for the purpose of seeking investors or capital
Different types of investors focus on different stages of business. If you’re at the startup phase, pre-revenue—perhaps even pre-product—you may find a startup angel. In these cases, you can’t show a historical P&L, patented technology or equipment that have a logical or quantifiable value. At this stage, a company’s ‘potential valuation’ is based heavily on the vision of the founder, their assessment of a market need, the value of that market segment or category of offering, etc. These types of early, lead angels will assign a percentage of the entire venture they are willing to take in exchange for funding. They often will develop a terms sheet that enables you to buy back or earn back your equity.
If you are a second-stage or more mature business, the tangible cast of financial instruments, audits, market sizings, sales reports, profitability trending, and more will likely be used to assign valuation. Unless there is going to be a change in ownership, at this point an investor is primarily interested in ensuring the business itself and its value or cash flow will make good collateral against their investment. Most investors, banks included, have a laundry list of items they will require from you and your CPA to review your financial health and estimate value. Make sure you are conversant with these documents, understand them, and head-off any oddities in your financials prior to being asked to see them. CPAs often can assist you with this process.
Valuation for the purpose of bringing in partners or sharing equity
The process of ‘doing deals’ is an odd one. It’s another place where the sole or majority shareholders may have an emotional, subjective view of value. The process of determining valuation is a first step here. The subsequent process of determining how shares will change hands—additional investment, earning shares in lieu of salary, etc.—is a whole different exercise. This can be made more complicated in a services business where there are less fixed assets and where individual’s worth or value to the enterprise is likewise subjective. For the purposes of valuation, there are often consultants with experience in a given sector or business type who have relevant business examples to draw on to help in assigning value. Also, larger CPA firms may have a separate department that focuses on valuation. These groups are typically separate from the CPA, similar to audit, to ensure an objective view is taken when assigning value. When a mutually agreeable value has been determined, a corporate attorney or legal consultant that focuses on private equity deals is the best person to engage to assist with the negotiation. Too often, shareholders attempt to do gentlemen’s agreements to avoid uncomfortable discussions. Now is the time to have any potential uncomfortable discussions, with independent people representing the shareholders, before the deal is done. In this way everyone begins the new partnership on the right foot, with the appropriate consideration so they can begin immediately growing the value of the collective and not arguing about the details of an equity exchange.
Valuation for the purpose of a sale
When it’s time to sell, a different group of experts is needed for valuation. You will of course need all the financial documents discussed before, ideally these have been audited by pros to start you off on stronger footing. These advisors for smaller businesses may be brokers or consultants that are expert in your sector. If your business is larger, let’s say closer to $10 Million, you will likely be interviewing investment bankers to represent you in a deal. Investment bankers have their own formulas, protocols, valuation teams and will typically pitch you on their approach to assisting you with a sale, including their rough estimates on determining your valuation. It is important to have advisors that can help you with both Fair Market Value and Investment Value. In a Fair Market Value sale, you make be talking about ‘multiples’ on your revenue and profit or comparables of other companies sold. Your assets, cash and other objective factors will be calculated. The more interesting discussions however come from the area of Investment Value. This is where most sellers get excited because the businesses’ value is viewed in relation to the prospective buyer’s gain or value from the buy. My company supported one business with their branding, lead generation and sales force effectiveness as they went through a sale. Their Fair Market Value was estimated at about $70 Million. In developing their markets and working with the investment bank, a motivated or ‘strategic buyer’ was uncovered. This buyer benefited from adding key accounts the business had, removing a key competitor that stood between them and several deals, and helped them add geographic coverage where they had no footprint. The Investor Value came in at $130M. This one example should give you major clarity on difference between the Fair Market Value and the Investment Value of your company.
Do you know what you’re worth?
The moral of this story is that many professionals can help you do the sometimes confusing and elusive exercise of determining what you’re worth. Don’t be taken in by the first person that tells you, you are worth a fortune. Be sure to check references. And be prepared to start getting phone calls from these individuals once your revenue exceeds $3 Million.
What’s important is to know why you are determining your valuation, who stands to gain from the final figures and the expertise of those best equipped to help you determine valuation and represent you. Just remember, before you do the process of finding an expert, make sure your financial house is in order. The cleaner your books are and the more aware you are of the impacts that grow your revenue, profit and growth segments, the better armed you’ll be when the questions and document requests begin to fly.
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