How much is my business worth the importance of valuation

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How much is my company worth? The importance of valuation

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• Valuation is the total price of a company at a specific point in time

• In short, your company is worth what an investor is willing to pay for it (ie what the market says it’s worth)

What is Valuation?

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When should you valuate business?

• Entrepreneurs will look to valuate their company prior to raising funds, as the amount you want to raise determines valuation

• Raise just enough to achieve next milestone, and then come back with higher valuation

• Entrepreneurs should approach the negotiating table with a well formulated and supported valuation.

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Why is it so Difficult?

• “Valuation is more an art than a science”

• While there are commonly used methods to estimate company value, rarely if ever are they the official “Valuation” of the company

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Why is it so Difficult?

• Due to the factors mentioned earlier (market, industry comparisons, company performance, etc), valuation is very volatile and unpredictable

• Raising money puts a very un-ambiguous stamp of “worth” on what you’ve worked so hard to create

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Difficulties for Early-stage Businesses

• For Early-stage businesses (which are almost always private), this is even more difficult:

–Lack of historical data–Lack of effective comparables (reporting and like-to-like)–Lack of proof of concept

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• A lot of it comes down to negotiation

• The market wants a winner – it’s your job to convince the investor that their investment can lead to exponential growth

Difficulties for Early-stage Businesses

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Bottom Line

• Be reasonable – value comes in with investment, so doesn’t matter what numbers say, it’s about market validation

• No point valuing yourself high if no one invests in you

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Q&A

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Valuation Methods

• Comparables/Multiples

• Discounted Cash Flow (DCF)

• Cost to Duplicate

• Berkus

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Method 1: Market Multiple (Comparables)

• The market multiple approach values the company against recent acquisitions of similar companies in the market.

• This method is a VC favourite, as it gives them a good idea of what the market is willing to pay for the company

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Market Multiple (Comparables)

• First, you find a list of the closest companies to you• i.e. industry, size, market performance

• A multiple is then assigned based on financial figures, such as:–EV/Sales–EV/EBITDA

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• Advantages:

–Accurate and indicative of market demand

–This gets us closest to the answer above that “valuation is what the market will pay.”

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• Disadvantages:

–Difficult to find close multiples for early stage companies

–Private companies do not disclose figures

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Method 2: Discounted Cash Flow Method

• The value of a company today is equal to the present value of the future cash flows discounted at a rate that reflects the riskiness of those cash flows.

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Discounted Cash Flow Method

• In English, this means a company is worth today what it can potentially achieve tomorrow.

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• Relies on the Time Value of Money principle, which assumes that a dollar today is worth more than a dollar tomorrow


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Step 1: Forecast finance projections

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• Step 2:

• Determine discount rate

• This is based on risk and potential return of the business:

• For early-stage businesses this tends to range from 20 - 50%

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Step 3: Apply formula

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• Advantages:

–Allows a company to value itself based on its future potential

–For companies with no comparables or tangible assets

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• Disadvantages:

–A very volatile method

–Forecasting is often inaccurate

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Q&A

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Method 3: Cost to Duplicate

• Assumes a company is worth how much it would cost to build another company just like it from scratch.

• The idea is that a smart investor wouldn't pay more than it would cost to duplicate.

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• We’re in the shoe making business:

• $250,000 for 18 months development• $50,000 equipment• $150,000 labor costs

• Therefore, it would cost $450k to duplicate

Cost to Duplicate

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Cost to Duplicate

• An example of this is the Yahoo purchase ($164m) of Maktoob • They bought it because it would take 18 months to build Arabic

functionality

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Cost to Duplicate

• Advantages:

–Easy and quick

• Disadvantages:

–Unreliable when it comes to intangible assets

–Doesn’t measure the potential of the business

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Method 4: Stage (Berkus)

• Values company based on the venture's stage of commercial development

• The further the company has progressed along the development pathway, the lower the its risk and the higher its value.

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Method 4: Stage (Berkus)

• Often used by angel investors

• Quick, rough-and-ready range of company value

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Stage (Berkus)

• Quality of the Management Team

• The soundness of the idea

• Whether there is a working prototype

• The Quality of the Board

• Product Rollout / Sales

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Stage (Berkus)

• A valuation-by-stage model might look something like this:

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• Advantage:

–Quick and easy

–Checklist

• Disadvantage:

–Overly simplistic and generic

Stage (Berkus)

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Q&A

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So What Can You Do?

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Combine

• DCF = 1,000,000• Multiples = 750,000• Berkus = 1,500,000• Duplicate = 500,000

• Take an average: $900,000

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Tell a good story

• A valuation is only as good as you can sell it — an investor is really interested in what a business can become rather than what it is now.

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A final takeaway

• Be reasonable – value comes in with investment, so does’t matter what numbers say, it’s about market validation

• Valuation is also contingent on the terms — more generous terms can yield a higher valuation.

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Q&A

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Thanks for attending. We hope you enjoyed it.

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How much is my business worth the importance of valuation

Small Business & Entrepreneurship

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