Top Tips to valuing your business
Founders typically establish a business with one of two game plans in mind. They either want a lifestyle business and one that fits their work life balance, or they want to build a business and grow it with the ultimate goal of building something of value that they can exit when the time is right for them. For any founder seeking to raise finance for their company, or to sell it, whether a lifestyle one or one with more ambitious plans, there will always be the need for a valuation.
For mature companies, and certainly publicly traded ones, there are a number of valuation methods that are accepted by all. These would typically be price / earnings ratio or discounted cash flow, but both of these methods require solid data over a number of years and often are better suited to companies with more forecastable growth.
However, for early stage businesses, valuing a company is much more of an art than a science because the business will not have the long track record to use as a basis, and often the valuation is based on future expectations rather than present or past trading. These vagaries make the process much more difficult and, it has to be said, the final valuation arrived at more open to interpretation.
Accepting that valuing an early stage business can be a challenge, what are the top tips to arriving at a solid and defendable valuation?
- Comparison – One way that is often used is by researching similar companies and how much they have been valued at when raising finance or being bought when they were at a similar stage of development. This of course can only ever be an indication, but if it is possible to cross reference a number of similar companies then this starts to give a general picture.
- Price / Earnings – This method might still be looked at but will be based on forecast future earnings rather than present earnings as early stage business that are growing have much higher ratios as sales are expected to increase greatly in coming years as the company grows. This makes it much less reliable and so it is not often used.
- Scorecard – Perhaps the best method to value a company in these circumstances is by using a balanced scorecard. This asks a series of questions such as the business sector and size of the potential market, how experienced the founder and team are, is there an advisory board, is the company pre revenue or profitable, what will forecast sales be in 5 years’ time, will the founder be open to training or stepping aside, and many other such questions. Using algorithms, it then calculates a valuation range. There are a number of such scorecards publicly available and many others available from paid sources.
- Return on Investment – Venture Capital funds and other professional investors look to make a certain minimum level of return on their original investment and use this as the basis for valuing a company, and so how much they will invest and on what terms.
To complicate matters more, the valuation of your business will typically be higher if you are aiming to raise funds via crowdfunding than if you are in negotiation with a VC firm, and probably different again if you are in negotiations to sell your business. Valuation is a complicated topic and one which is only lightly touched upon here.
The top tip then is to use a combination of all of the above valuation methods and this will undoubtably provide a range of valuations. Hopefully the valuations will be similar and, if they are, this then gives a good guide to a realistic valuation. As the founder it is then important to be prudent and not to try and over value the business but to settle on something that can be defended.