Creating a startup is a lot of work. From coming up with ideas to finding a location for your business, there is a long checklist to cross out. When you are ready for investors to take a look and help you out, then that is the time to get a valuation of your company. But, investors aren’t the only reason why your company needs a valuation. In fact, it could be for a number of reasons such as:
- The business is being sold
- You want to sell stock
- You need a bank loan
- To understand your company, you want it evaluated.
What is Valuation?
Valuation is also known as company/business valuation. It is the process in which a company is asked for all of its economic worth along with its assets. The process requires that all factors of the business be analyzed for the most accurate and precise readings of the data.
How do you Valuate a Business?
Company valuation actually has several different methods in order to reach its goals. There are two ways that are the most common to use. They are known as the multiples method. Also known as the comp method. The other way to do a valuation is the discounted cash flow method (DCF). The DCF is a more complicated way while the comp method is much easier. For the sake of being easy, we will take a look at the comp method.
However, it is stated that you should at least attempt both methods. For the comp method, you need to find the multiple of revenue from your EBITDA (earnings before interests, taxes, depreciation, and amortization) when it was sold. Next, you multiply it by your most current EBITDA or your revenue.
As for the DCF, you just need your forecast of the company’s earnings (about five years) and then calculate the present net value.
Step 1: Don’t Value Capital Assets
Now, you are not a wizard of the finance world, you’re a business leader. You may or may not know this, but asset value is different from business value. These are two separate factors of your business. But, don’t fret as it is a common mistake.
For example, let’s say that your business is worth $900,000 from supplies, finances, office space, and other parts. If you sold all of that then that is what the business is worth, meaning how much you would receive if you sold it.
But remember, your company’s worth is not what is important. What is important is the amount of money that has a connection to your business. Investors and shareholders are not going to be interested in how much they could make from selling your company, Rather, they want to know how much they can potentially make from the services you provide there.
Step 2: Understand Profitability from Valuation
So, now you know that a business doesn’t have a valuation in its assets, but its profits.
Your company valuation is to understand the money you are presently making and what money you will be making in the future. Buyers need to know how much money they will be making if the company falls into their hands.
Some of the factors that need to be understood for valuation include:
- Your salary
- Base Wage
- Net Profits
- Gross Income
- Outgoing Payments
Besides these, a valuation also requires two other factors: Multiples and Profitability adjustments.
Multiples refer to the ratio of one business metic to an estimated value. Public companies market the value of a business. Multiples can range from 2-10 and it depends on the size of the company and factor in risk. Huge corporations are able to know their longevity way into the decades and even centuries! Smaller companies are in the 2-10 and that is about the median. You then multiply your profits by whatever multiple is rational for your business.
Profitability adjustments are when the company is not making the same amount of profit consecutively. When you have a valuation of your business, you need to discover the growth and the profit losses when you apply it to the multiples. You must look at three things:
- Competitor’s Progress
- Market’s Expected Growth (Your Own)
- Financial Data of your Company
Be sure to keep all of your records or it will become more difficult for the valuation. When all data is available, you have your answers in a day or more.
Step 3: Value Calculation
The good news is that if you are organized with your papers and your data, it doesn’t take long at all. If you are in the middle of moving financials around, then it can take up to months to get done.
First, you need to know the gross profit of your business and subtract the expenses. Next, you need to figure out your multiple. The smaller the business, the lower the multiply you are expected to make. Some of this requires guesswork and there is no actual set way of going about it. Instead, you need to ask a few questions.
- Research the industry
- How healthy is your financial history?
- Is it stable enough for better multiples?
- What will be the fate of your business when you leave it?
- Do you have guaranteed income for the years to come?
- How big is your customer base?
- What is your relationship with your suppliers?
To get a better understanding of the multiple, look at these tips:
- A business by a single person will not sell for a multiple over three.
- Revenues up to $500,000 are usually maxed out at five.
- Those with over $500,000 are expected to make it into the double digits.
To increase the value of potential growth for the company. To do this, you need:
- History of the company’s growth
- Market growth (Your own)
Next, you need to figure out the market. That requires:
- If you are in a stable market, then it’s recommended to use your historic numbers.
- If you are new to the market, then you have the opportunity to grow.
For the next phase, you need to know the potential market growth rate. To do this, you compare the market rate when you first started to what your business’s market rate is in the present.
Lastly, add growth. Use your historic data in order to find the company’s growth for the next few years. Simply add 10% each to the profits you make. Multiply by increments instead of adding it to your current figure.
Step 4: Market Valuation Calculation
You now have a valuation. Now show it to buyers, investors, and more! But, no matter how much you put in the effort, the market will decide your fate.
Market value is often the most reliable way to get an estimated value. When you are in your meeting with buyers, you can inform them of your valuation number and the furthest you can go with that money. From there, investors will either accept it or won’t.
If you can’t get the full amount from your buyers then it is not an approved value. If investors don’t think your business is worth what you say it is, good chances are, that they are right.
While you may have to compromise, then so be it. A business only has work when the market has a demand for it. Sometimes factors like supply issues or larger events like the coronavirus can make your business more important than others. Thus, this can lead to greater or lesser value for your business.