Mar 10, 201610:17 AMOpen Mic
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What's your company worth?
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When I talk to business owners about selling their companies, one of the questions I’m always asked is, “What is my company worth?” I have quite a bit of finance and valuation education and experience, so after analyzing a company’s financial statements, risk factors, and market variables, I can determine a theoretical valuation for the company. However, theory only determines what the company should be worth, while real buyers in the market determine what it is really worth. John Naisbitt summed up market-based valuation best with his famous quote, “Value is what people are willing to pay for it.”
Theoretical valuation is an academic method for estimating the value of a company. For stable and mature companies, the easiest starting point for valuation is determining what the EBITDA (earnings before interest, taxes, depreciation, and amortization) multiple is for companies with similar characteristics, then multiplying that factor by the EBITDA of the company. Likewise, for some companies it is more appropriate to determine a revenue multiple for similar companies and multiply that factor by the revenue of the company.
Another theoretical method commonly used is the discounted cash flow (DCF) method, which discounts the projected free cash flow of the business by an appropriate risk adjusted rate of return to determine a present value of future cash flow and thus the value of the business.
Yet another theoretical valuation method focuses on net asset values in either an orderly liquidation or forced liquidation situation. The multiples and discounted cash flow methods should lead to similar valuations that are a good indicator of theoretical valuation, while the asset value methods are more appropriate for setting a valuation floor. Despite their academic and theoretical basis, none of these valuation techniques will necessarily lead to the sale price of a business.
A business owner can never really know what their business is worth until they sell it. When a sale occurs it is a clear indication of the value at least one real buyer puts on the company. The best way ensure that maximum value is achieved is to create a market for the company by inviting a group of interested buyers to evaluate the relevant information about a company and make an offer to buy it. When multiple offers are received and simultaneously negotiated, the maximum valuation is quickly discovered. Each potential buyer will evaluate the company from their own perspective, adding value for opportunities they identify for the company, and subtracting value for perceived risks.
The benefit of this method is that there will inevitably be a buyer who sees more opportunities and fewer risks with the business than others evaluating the opportunity. We have seen buyers who wanted to gain a quick foothold in a market pay an EBITDA multiple of 20 for a company with a theoretical value of five times EBITDA because they determined that strategically they just could not risk losing the bidding process for the company. We have seen financial buyers pay six times EBITDA for a company when all other buyers were willing to pay only four times EBITDA because that financial buyer had not completed a deal in two years and was feeling pressure from its investors. We just cannot know what will drive buyers to bid more than theoretical value until they are given the chance to buy the company.