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Is business valuation in the eye of the beholder?

03 May 2017

The Concept of Value

The concept of value is a term we probably all feel familiar with but, given its subjectivity, one that evokes great emotion and diversity of opinion.  Value or worth is, of course, a personal view as the value of something can differ greatly in the eyes of individuals where one has a particular need for, or attachment to, the asset in question.  This is particularly the case for assets which are unique or have rarity value such as works of art, antiques and vintage cars.

In a business context, we have seen a proliferation in the valuation methods applied to businesses, some of which seem to have little bearing on the underlying performance or short-term prosperity of the asset in question.  The last few years have seen the emergence of the so-called “unicorns”, the fast-growing breed of start-ups worth in excess of $1 billion.  Notable examples being Snapchat at $23.2 billion, Facebook paying $19 billion for WhatsApp (which had no meaningful revenue) and Uber being valued at over $68 billion which represents 39 to 45 times its revenue.

Closer to home those of you who watch Dragon’s Den, which invites budding entrepreneurs to pitch for investment from five successful investors, will have been mystified at the unrealistic valuations owners ascribe to their businesses.  This is as much to do with their naivety as it is being misguided and poorly advised.

The vagaries in some of these valuation methods leads us back to the view that value has to be capable of being measured objectively based on clearly defined principles.  So, what does this mean for owner-managers looking to assess and increase the value of their businesses?

What is my business worth?

This is without doubt the question we are asked most often when meeting with shareholders and entrepreneurs.  It’s obvious why – many of these individuals have invested years of time, effort and resource into building their business.  This is often combined with long periods of significant personal sacrifice so the emotional attachment to value is palpable.

The output from a successful business transition process, whether by internal or external sale, is a one-off opportunity to crystallise value.  For most owner-managers it can be a life-changing event, providing a pension fund for retirement and a legacy to leave to future generations.

A business is ultimately worth what someone will pay for it.  Whilst this is inevitably a truism it’s not particularly helpful to a business owner looking for advice and guidance on what the business will realise in a properly planned and executed transition process.

What do we mean by valuation?

This may sound like an odd question but we come across lots of business owners who don’t fully understand how businesses are valued.

When talking about the valuation of a business we talk about “enterprise value” and “equity value”.  Enterprise value simplistically means a maintainable profit number (usually EBITDA) applied to a multiple which reflects, amongst other things, the quality of earnings, scale, competitive positioning and future prospects of the business.

Whilst valuation methods are a well-trodden path each business is unique and requires careful consideration and positioning.  It is the ability to be able to properly convey the key selling points of the business, engage with the optimum buyer pool and create competitive tension which will ultimately deliver the best result.

Equity value is the proceeds which the shareholders receive on sale of the business after taking account of debt and cash in the business, levels of working capital and significant capital expenditure requirements and so is the more pertinent metric.

How do I grow the value of my business?

This is a question which is asked far less but in some ways is more important, particularly where there is a gap between the “market value” of the business today and the owner’s assessment of value or a target minimum consideration requirement.

Outlining all the factors which may lead to an increase in business value is a significant topic in itself and each strategy needs to be tailored to individual circumstances.  Focus should be on factors which will increase the maintainable earnings of the business, the multiple a purchaser is prepared to pay and maximising the benefit of adjustments made in arriving at the equity value paid.  It will come as no surprise that the best outcome results from careful consideration and management of all three.

When considering the best way to increase the value of your business think of it in the context of how you can make it look more attractive to a purchaser, making it easier and cleaner to assess during due diligence and how you can mitigate any separation or integration issues in advance of approaching the market.

Notes:

Simon Marsden is a Director at Gambit Corporate Finance LLP, a leading independent corporate finance advisory firm specialising in advising private and public companies on mid-market transactions in the UK and overseas.