How To Know How Much Your Business Is Worth – Summary. Most owners and managers of medium-sized private companies (family-owned and otherwise) operate day-to-day without a clear understanding of their value. Unlike their publicly traded counterparts, they do not have the advantage of automatic daily valuation based on the share price, nor do they have teams of corporate strategy managers standing by to analyze value creation. Many mid-sized company leaders also view third-party valuations as complicated, time-consuming, intrusive and expensive. Therefore, they only go through them when they have to – for example, when looking for capital for growth. If you are the owner or manager of a medium-sized company, it is imperative that you conduct a detailed valuation at least once a year. You can avoid spending precious resources courting the wrong customers, trying to grow areas of your business that are necessarily in decline, and failing to recognize and invest in your areas of greatest opportunity. Additionally, if you are approached by a buyer interested in purchasing your company, you will be ready to respond and negotiate. The authors present an easier and more accessible method for valuing your company.
If you own or manage a mid-sized company, do you have a solid understanding of its value? Right now, right now? Do you know for sure how much value you created in the last year? Can you pinpoint where in your business value is created and where it is lost?
How To Know How Much Your Business Is Worth
If the answer to any of these questions is “no,” you could be putting your company’s future at serious risk.
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Recently, one of us (Reed) advised a family-owned company that operated three distinct business units, each in a different industry. Two of the units have done well in promising industries while the third is lagging in a declining industry where valuations have been at an all-time low and are unlikely to recover. Unfortunately, instead of devoting most of their time and energy to improving the top performing businesses, management is busy trying to fix the struggling businesses.
The damage caused by this approach only became clear when the company was sold. Because the three business units were in different industries, the sale involved three separate buyers. The top performing businesses earned about $75 million each. The struggling business – getting so much of their attention – is only $12.5 million short.
Imagine what the value of the combined company could have been if management had focused its efforts on businesses worth improving by investing in creative talent and innovations, expanding the customer base, fine-tuning quality, and the like. In a few years, a focused growth strategy might have improved those already promising enough that buyers were willing to pay a 25% premium, or $100 million each, instead of $75 million. Even if these investments required closing the third business, the combined $50 million increase in market value would more than offset the costs of closing a bad business.
While any company can make these types of mistakes, family businesses may be at increased risk. Their rich histories and traditions (which are usually among their strongest assets) can become liabilities if emotional attachment causes leaders to hold on too long or resist taking new directions. For such companies, clear and objective valuations offer essential reality checks.
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Unfortunately, most owners and managers of medium-sized private companies (family-owned and otherwise) operate day-to-day without a clear understanding of their value. This is because busy managers often assume there is no easy way for them to determine value and simply put the issue aside. Unlike their publicly traded counterparts, they do not have the advantage of automatic daily valuation based on the share price, nor do they have teams of corporate strategy managers standing by to analyze value creation. Many mid-sized company leaders also view third-party valuations as complicated, time-consuming, intrusive and expensive. Therefore, they only go through them when they have to – for example, when looking for capital for growth.
Despite these challenges, if you own or manage a medium-sized company, it is imperative that you conduct a detailed valuation at least once a year. Think of it like you think of your annual physical—an essential step in finding out what’s going right, and more importantly, what might be going wrong. Then, you can take corrective action before it’s too late. You can avoid spending precious resources courting the wrong customers, trying to grow areas of your business that are necessarily in decline, and failing to recognize and invest in your areas of greatest opportunity. Additionally, if you are approached by a buyer interested in purchasing your company, you will be ready to respond and negotiate. Instead of fishing for some vague “X times EBITDA” figure you heard at your last industry conference, you’ll have a clear idea of what
To make the valuation exercise easier and more accessible, we created a new methodology called QuickValue. It’s based on Reid’s experience working directly with hundreds of midmarket leaders, helping them better understand what their companies are worth and why. To perform this type of self-evaluation, your internal team doesn’t need future financial projections—most of what you need is on hand, and what you don’t can be easily obtained. Your company executives know the business better than any consultant ever will, and they won’t have to put anyone up the learning curve.
Our approach to this exercise emphasizes careful analysis of your company’s most important value drivers: those characteristics of your business that make it unique. Even companies in the same industry and with similar metrics can vary widely in everything from the quality of their leadership to pricing power to brand equity. Therefore, a careful, thorough and honest assessment of these value drivers is essential to calculating the value of an individual company.
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First, identify the value drivers most important to your business—we suggest choosing eight to 12—and then rate each one on a scale of zero to 10, with 10 being the best, to create your value driver score. This score is an important component of your valuation because it quantifies the qualitative aspects of your business that most other valuation methods ignore. You and your team then use public company market multiples to estimate the value of businesses similar to yours. Finally, if you are a mid-sized privately held company, you will need to match the lower multiples (typically 25-30% lower) of M&A deals involving private companies.
The next step involves putting everything together. While getting the three essential pieces of data—your estimate of your value drivers, your EBITDA multiplier, and your adjusted EBITDA—requires serious work, after that, a fairly simple calculation yields the number you’re looking for: clear, well-supported value for your business .
Consider the following hypothetical example. Company X is approached by a competitor with a purchase offer. The price, the competitor says, will be based on a widely used industry multiple of 12 times EBITDA. Both companies are in a fast-growing industry, and both are performing well.
Fortunately, Company X’s executives recently completed a self-assessment of their company’s value, and believe they have a strong and defensible case for valuing their company at 18x EBITDA, rather than 12.
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How did they get there? An internal team of four senior executives covering the core disciplines—finance, product, marketing, and manufacturing—worked together, debating which value drivers were most important. Forgoing drivers that don’t apply to their software business, such as the supply chain and franchisor-franchisee relationships, the team determined that areas like intellectual property, leadership and pricing power were critical to their development and success.
They then rated themselves on each driver using a scale of zero to 10 with additional emphasis on drivers they considered particularly important. It was a vigorous, honest and revealing conversation. They made sure to judge themselves thoroughly, including both the drivers they excelled at and the inevitable ones they needed to improve on. They added these ratings together to arrive at their overall score of 112 out of a possible 140 points. Although the team rated only 10 valuable drivers, one was considered critical and received triple weighting (30 possible points), two were defined as very important and received double weighting (20 points), and the remaining seven had a normal weighting of 10 points. Using our system, they received a Value Driver score of 80% (112 points divided by 140) – a very high score given only to the best companies.
Next, they looked at the EBITDA multiples of 15 public companies in Company X’s industry. (In this case, an investment banker they knew provided this information, though there are several ways to gather it quickly.) This allowed them to develop a valuation range, which they changed slightly downwards to explain the difference between public and private companies mergers and acquisitions. The range, which was 10x-20x EBITDA, is where Company X will find its value once it applies its score. The company’s strong score places it at the high end of the 18x EBITDA range, as seen in the table below.
If Company X was purchased at its price
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