How To Know What Your Business Is Worth – Generalize. The owners and managers of most mid-sized private companies (family-owned or otherwise) do not have a clear sense of their value in day-to-day operations. Unlike their publicly traded peers, they do not have the benefit of automated daily valuations based on share prices, nor do they have a team of corporate strategy executives on call to analyze value creation. Many midsize business leaders also find third-party valuations complex, time-consuming, invasive, and costly. As such, they only take them when they have to—for example, when seeking growth capital. If you own or manage a mid-sized company, a detailed valuation must be done at least once a year. You can avoid spending valuable resources attracting the wrong customers, avoiding trying to grow areas of business that inevitably decline, and failing to identify and invest in your best areas of opportunity. Plus, if you are approached by a buyer interested in acquiring your company, you’ll be ready to respond and negotiate. The authors propose a simpler and easier-to-use approach to company valuation.
If you own or manage a mid-sized company, do you have a solid understanding of its value? Right now? Are you sure you know how much value you have created in the past year? Can you point out where your business value is being created and where it is declining?
How To Know What Your Business Is Worth
If you answer no to any of these questions, you could be putting your company’s future at serious risk.
What Is My Business Worth?
Recently, one of us (Reed) advised a family business that ran three different business units, each in a different industry. Two of the units are doing well in promising sectors, while the third is lagging in a declining sector where valuations are historically low and unlikely to rebound. Unfortunately, instead of devoting most of its time and energy to improving the well-performing business, management has been trying to fix the struggling business.
The damage done by this practice became apparent only when the company was sold. As the three business units are in different industries, the sale involves three different buyers. Top performers received about $75 million each. The struggling business — which has received so much attention from them — only got $12.5 million.
Imagine how much the combined company would be worth if management had focused on the businesses that deserved improvement by investing in creative talent and innovation, expanding the customer base, fine-tuning quality, etc. A few years from now, targeted growth strategies may enhance already promising businesses to the point that buyers are willing to pay a 25% premium, or $100 million each, instead of $75 million. Even if these investments require closing a third business, the combined $50 million in market value enhancement more than covers the cost of closing a distressed business.
While any company can make mistakes of this nature, family businesses can be at greater risk. If emotional attachments cause leaders to hold on for too long or refuse to embrace new directions, their rich history and traditions (often one of their strongest assets) can become a liability. For these companies, clear, objective valuations provide a necessary reality check.
Business Value Is Derived From A Formula, Not From Hope
Unfortunately, the owners and managers of most mid-sized private companies (family-owned or otherwise) do not have a clear sense of their value in day-to-day operations. That’s because busy executives often think there’s no easy way for them to determine value and simply put the topic aside. Unlike their publicly traded peers, they do not have the benefit of automated daily valuations based on share prices, nor do they have a team of corporate strategy executives on call to analyze value creation. Many midsize business leaders also find third-party valuations complex, time-consuming, invasive, and costly. As such, they only take them when they have to—for example, when seeking growth capital.
Despite these challenges, if you own or manage a mid-sized company, a detailed valuation must be done at least annually. Think of it like your yearly physical—it’s an important step in finding out what’s going on and, more importantly, what might be wrong. You can then take corrective action before it’s too late. You can avoid spending valuable resources attracting the wrong customers, avoiding trying to grow areas of business that inevitably decline, and failing to identify and invest in your best areas of opportunity. Plus, if you are approached by a buyer interested in acquiring your company, you’ll be ready to respond and negotiate. Rather than overhearing some vague “X times EBITDA” number at the last industry conference, go fishing and you’ll know exactly what
To make valuation work easier and more understandable, we have created a new method called QuickValue. It’s based on Reed’s experience working directly with hundreds of mid-market leaders, helping them better understand what their company is worth and why. To perform this self-guided assessment, your internal team doesn’t need future financial projections—most of what you need is on hand, and what you don’t is readily available. Your company’s executives know the business better than any consultant, and they don’t need to push anyone up the learning curve.
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Our approach to this exercise emphasizes careful analysis of your company’s most important value drivers: those business characteristics that make your company unique. Even companies in the same industry and with similar metrics can vary widely in everything from leadership quality to pricing power to brand equity. Therefore, a careful, thorough and honest assessment of these value drivers is critical to calculating the value of an individual company.
How To Calculate A Business Valuation?
First, you’ll identify the value drivers that are most important to your business – we recommend picking 8 to 12 – and then rate each on a scale of 0 to 10, with 10 being the value driver that most creates your factor score. This score forms an important element of your valuation because it quantifies a qualitative aspect of your business that most other valuation methods ignore. You and your team then use market multiples of public companies to value businesses similar to yours. Finally, if you are a private mid-cap company, you need to adjust for lower multiples (typically 25-30% lower) for M&A deals involving private companies.
The next step involves bringing them together. After getting the three key figures – your assessment of value drivers, your EBITDA multiple and adjusted EBITDA – some serious work is required, after which a fairly simple calculation should yield the numbers you want: A clear, well-supported value for your business.
Consider the following hypothetical example. A competitor makes a takeover offer for Company X. Rivals said the price would be based on a widely used industry multiple of 12 times EBITDA. Both companies are in a fast-growing industry, and both are doing well.
Fortunately, Company X’s managers have recently completed a self-assessment of their company’s value and believe they have good reason to value their company at 18 times EBITDA instead of 12 times.
What Is Your Business Worth?
How did they get there? An internal team of four senior executives covering core disciplines (finance, product, marketing and manufacturing) worked together to discuss which value drivers were most important. The team eliminated drivers that did not apply to their software business, such as supply chain and franchisee-to-franchise relationships, identifying areas such as intellectual property, leadership, and pricing power as most important to their growth and success.
They then self-rated each driver using a scale of 0 to 10, highlighting drivers they deemed particularly important. It was a dynamic, candid and thought-provoking conversation. They carefully and thoroughly judge themselves, both the drivers they are good at and the inevitable drivers they need to improve on. They added these ratings for a total score of 112 out of 140. Although the team scored only 10 value drivers, one was deemed critical and received triple weight (30 points), two were considered very important and received double weight (20 points), and the remaining seven With a regular weighting of 10 points. Using our system, they received a value-driven score of 80% (112 divided by 140) – a very high score awarded only to the very best companies.
Next, they examine the EBITDA multiples of 15 public companies in Company X’s industry. (In this case, an investment banker they knew provided the information, although there are ways to gather this information quickly.) This allowed them to develop a valuation range, which they then revised slightly downwards to account for the public and the difference between the public. Private company M&A multiples. The range is 10x to 20x EBITDA, which is where Company X will find its value after applying its score. The company’s high score puts it at the high end of the EBITDA range at 18 times, as the table below shows.
If Company X is based on its
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