2010.43 Business valuation: the intangibles
Business valuation is – at its core – essentially numbers driven and many models exist. For indications of value, we can look at comparable company valuations either based on the price of publicly traded stock (adding a premium for liquidity) or a recent fundraising valuation for a similar company. We can use a discounted cash flow model, looking at future expectations of a company’s free cash flow and applying an appropriate discount rate. LBO (leveraged buyout) models, liquidation analysis and industry parameters (number of stores, etc.) can also be analyzed. All of the resulting valuation numbers or ranges can then be aggregated and a reasonable valuation based on the range can be estimated.
The models above are somewhat driven by company projections of future results; as is valuation. A company growing quickly and more profitably will be perceived as having a higher value than will a slower growth (and less profitable) one. Yet, valuation indications are only as good as initial assumptions and projections are often wrong. They also don’t add in surprise events.
What ultimately won’t matter much: the last round valuation (ask anyone who has ever done a down round or been de-listed from an exchange for not maintaining a share price as per exchange rules), unsupportable management or shareholder expectations and the valuation of a high profile, heavily pursued company.
Other less quantifiable factors also need to be considered in any business valuation exercise.
1. How much cash you have left and your burn rate. If a potential investor can figure out that you are out of cash (or when you will run out of cash and it’s soon) your valuation will be lower.
2. Whether you are cash flow positive; the quality of your customers and how concentrated they are.
3. Management: quality, proven results, how well the team presents, their experience and how well they are respected.
4. The market size for your product.
5. The company stage (product completed, customers, revenues, profits, etc.).
6. Growth rate of revenues and EBITDA.
7. Margins.
8. Competition, and how well funded it is.
9. The overall market – in 2009 fundraising valuations plunged in part due to the much lower public company valuations (with private companies having a harder time raising money; public companies were trading at what was traditionally lower private company valuations but with added liquidity).
10. The availability of credit. Financial buyers generally need to leverage a purchase; if credit isn’t generally available they can only afford pay a lower multiple (to make the requisite return on their investment).
11. The general confidence level of investors – with the current VC market being more conservative due to ten years of negative industry returns, concerns about continuing to fund – or save – existing portfolio companies and less money being raised.
12. How crucial a component you or your product is to a potential buyer or their competitor.
13. How scarce and desired what you offer is.
14. How much interest there is in your industry.
Certain of the above factors are less quantifiable yet are ultimately very influential. Realistically, all of the above factors impact valuation. Investment bankers always aim for the best valuation for their client. But we, like the rest of the world, are subject to market realities. The process you pursue and the quality of your deal team does help determine valuation.
