HOW TO VALUE MY COMPANY?
Sure, you want to minimize the number of shares that you will eventually give to the investors, but you don’t want to scare them off as well. Above all being reasonable is the key when it comes to valuing your own company.
But first, let’s talk about the theories behind asset valuation.
The idea that sits at the centre of a valuation is the concept of Fair Value.
Fair Value is the price that would be received to sell an asset in an Orderly Transaction between Market Participants at the Measurement Date.
This seemingly simple sentence pinpoints some basic key principles:
- Any valuation has its said worth during the moment at which it was created. Few days after that moment (hours/ minutes/ seconds or even microseconds in case of publicly traded companies) the business may have a totally different value
- The ideal transaction is carried out by rational actors in an open marketplace
- There are no special circumstances in which the transaction is carried out (that’s why when a company acquires a competitor because of a strategic advantage that it may get, it will normally pay a premium on top of the market value)
We could use several techniques to create a valuation that may reasonably close in towards the effective value that the market is willing to pay. In broader terms, valuation theory recognises four distinct approaches in the valuation of shares and businesses. These are:
- The Cost Approach
- The Asset-Based Approach
- The Market Approach (direct market comparison)
- The Income Approach
The Cost Approach is a last resort approach. When other methods are not applicable, this approach bases the valuation on the cost to create or replace the asset with a similar one, on the premise that a purchaser would not pay more for a business than the cost to obtain one of equal usefulness. This method is frequently used in valuing investment companies or capital-intensive firms.
The asset-based approach measures the value of a business by referencing the value of its individual assets and liabilities. This is the road that is usually taken in Real Estate, where properties represent the vast majority, if not the totality, of the company value.
The market approach provides an indication of value by gauging the company with comparable businesses for which some basic indicators are available.
Here is where you start hearing the term “multiple”. The market multiple method focuses on comparing the subject asset to similar, publicly traded, companies and assets. In this method, valuation multiples are derived from historic and operating data of comparable businesses.
MULTIPLE ON EBITDA
In particular the multiple on EBITDA is a simplistic approach but very handy in determining a ballpark in the range of values your company can expect from the market.
“My competitor sold/ got a valuation of 8x their EBITDA”
This may give you an idea of how much your company could be valued, based on your own EBITDA. Multiply it by the multiples you have gathered on the market and voilà! You have the answer to all your questions… But do you really?
Many factors weigh on the valuation of a company, and for sure there are no two businesses alike. Furthermore, even similar companies find themselves at different stages of their lives: some are consolidating and others expanding; some are profitable and others are not; some are not even generating revenues.
The income approach has a number of variants, but essentially this approach is based on the income that an asset is likely to generate over its remaining useful life. In case of a business, the earnings that it will generate in the future.
The Discounted Cash Flow (DCF) technique can be applied to any stream of cash flows and can, therefore, be applied to companies in a variety of situations, from listed companies to start-up in a pre-revenue stage.
DCF is our method of choice when assessing and valuing SMEs and start-ups.