How much is your business worth?

By on May 2, 2013

Working out the value of early stage, high-growth businesses is a dark art. Here, BDO’s valuation experts give some inside tips to help you work out how much you could sell up for.  David Mitchell and  Roger Wilcock reports.

The market value of anything is generally thought of as being the price at which a willing buyer will transact with a willing seller. Businesses are no different; however determining this value is a perennial question for CEOs and owners of private companies.

Valuation experts are often engaged to apply their analysis, experience and judgement to derive a value estimate for a particular business. Given the uncertainty of future prospects for a business, opinions may differ. The extent to which they differ will depend on the quality of information available in determining the key inputs to the valuation.

For mature businesses in sectors where there are lots of similar competitors, it is possible to benchmark indicators of value to the target business in question using market pricing information. It may also be possible to use the past performance of the target business, particularly financial returns, as a yardstick of expected performance in the future.

However, for early-stage and high-growth businesses, information is likely to be scarcer and the valuation assumptions required more subjective. This is due to the considerable uncertainty of future cash flow generation, a key determinant of value.

With any business valuation, there are many factors to be taken into consideration and it is important the business managers and owners are aware of and understand just how these drive value. Having a firm grasp on cash flows, asset values and competitor valuations is critical to maximise and accurately calculate an appropriate valuation.

The most appropriate valuation methodology depends on the circumstance, information and context, but it is worth remembering that each methodology has its advantages and disadvantages.

Two of the most popular methods are the discounted cash flow and multiples approaches, which are often used to value early-stage and high-growth companies.

The discounted cash flow approach establishes the market value of a business by calculating the free cash the business will generate in the future and discount it back to today.

This approach requires the use of a credible forecast, which captures all elements that comprise the free cash flows of the business (revenues, direct costs, operating costs, capital expenditure, working capital, tax etc.).

For the valuation of early stage companies, forecasts should be underpinned by a commercial rationale. For example, where possible, the forecast should reflect considerations such as the size of the total market and expected market penetration; the earning margins generated by competitors companies and initial and on-going investment required to achieve the projected market share.

Of course, there are many other considerations, which will vary depending on the context. Since discounting forecast cash flows is required to compensate an investor for the risks of their investment, the credibility of management is also a key factor and will often be captured in the discount rate applied.

Another way of valuing a business is to apply a “multiple” taken from a comparator company or peer group with observable market pricing (e.g. quoted share price or a completed transaction) to a metric of the target business. Multiples normally take the form of a ratio of market value to earnings estimates but can also be a ratio of market value to an industry specific measure.

With any valuation there is no “one-size fits all” approach. If attempting to value a fast-growing start-up business, try as best as possible to understand the business and the pros and cons of the valuation approach being applied and remember, value is a matter of opinion.

 

 

You must be logged in to post a comment Login

Leave a Reply