Posts Tagged ‘ valuation ’

Strategic Recasting – making your company more sale-able

Case study: A Northern California textile company – manufacturing and importing. Specializing in fine wool (men’s and women’s suits) and specialty fabrics. 12 years old, family run, $3.2M revenues. 2 woolen mills in Ireland. Steady if not impressive growth. Founder retiring, sons tired of business – will stay on for term. Company has weathered the decline of demand for men’s suits by branching into imported cottons and changing markets from men’s clothing to women’s fashion designers.

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The company is a solid performer in a fairly small niche. In preparation for sale, the company has re-stated its finances, and has paid a consultant to create reports describing the company, what it does best, and some of its future opportunities. (It sees its growth as doing ‘more of the same’ that’s kept it successful – moving to fashion houses and moving into specialty fabrics.)

In other words, this textile company has looked at its past and projected forward in order to talk about a likely future. It’s an Official Future that created by taking a straight-edge to past performance to predict what will happen.

Potential buyers look at the company, they look at the financials, and they try to imagine themselves as the new owners. Those with industry expertise will be able to see past the rose-y optimism of the consultant’s reports and will try to imagine themselves in charge of this company in 4, or 6 or 8 years.

What they need, and what they will value, is a kind of re-casting that talks about the future — or futures — of that company. We call it a “Strategic Recasting” report.

Strategic Recasting is the description of decisions the company should take if the overall business economy changes significantly. Many are broad questions dealing with supply and demand — in the case of this textile company for example, changes in consumer tastes and regulatory environments and changes in production or distribution technology. How will business opportunities change for example, if the US dollar weakens significantly, or if strict regulatory changes increase the cost of fabric-finishing? What happens if dramatic changes in textile production require massive retooling expenses, or if the cost of moving finished goods to market rises three-fold?

As a service, strategic recasting offers a way for a company being offered for sale to differentiate itself from similar ventures. It offers a way for potential buyers to see the long-term wisdom of buying *this* company rather than others.

Bottom line? We believe buyers will pay a premium for companies that offer this information.

how much can I sell my pre-profit startup for?

You’ve gone way beyond having a business idea that gets a  “wow” from people who aren’t related to you.  You’ve actually bought in some outside help and you have the beginnings of a real business – abeit your Wunder-Teknology is still residing in peoples’ head and in long Word files of various laptops.

BUT, the entrepreneurial life is nothing like you imagined it and you’ve decided to sell.

The grand question is for How Much.  Classic valuation doesn’t help much.  You’ve got no revenue.  Assets are limited – maybe – to a handful of lapops, some second-hand Aeron chairs, and hollow-door-on-file-cabinets work tables.  Intellectual property?  Mostly in your head.

So, how DO early-stage investors value such companies?  Let me talk about two methods here.

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METHOD 1:  Shopping for Comparable Terminal Value

The first bit of spit-and-windage number we need to determine is something called the ‘terminal value’ for the company — a value at some point (say 5 years) in the future. In 5 years, one assumes, there’ll have been a ‘liquidity event.” (IPO, or acquisition) And if that DOESN’T happen, this 5-year horizon’s got to be a point where your company will – finally – be making a profit. The easiest way to do this is to look at a comparable company. So – find a company in a similar offering space that’s gone public or was acquired and use that value as a kind of proxy for the guesstimate we’re looking for.

Simple.  Painless.  Full of potential hazards…

 

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METHOD 2: A ‘QUANT-JOCK’ TECHNIQUE: ‘I’ll invest if I think my return is sufficient.’

Lets say you determine that the barrier between your bright idea and a profitable company is about $2M:  enough to hire two part/time PhDs, a marketing person who can double in sales, and a whole lot of outsourced software development talent.  (to make the math simple, assume you think a one-time, $2M investment is all you’ll need).  OK – investors know this is a high risk bet and in such a case, they might reasonably ask that their $2M will – at the end of 5 years – give them a 50% annual rate of return. 

This means in year-5 the investors share of the now-profitable company must be worth (1 + 0.50)5 x $2M = $15.2M.  

Now – in order for this $15M’s worth of shares to be somewhat reasonable to the person selling the company, the investor works backwards.  Guessing and trying numbers in a simple spreadsheet.

A pound of flesh is one thing – asking an entrepreneur to give up 90% of their ownership a whole ‘nother.

In this case – the valuation guess (given the loan and the risk) – FOR FIVE YEARS HENCE – works out to about $45M and so, the investor’s ownership is 15.2/45 = 34%.

So the investor is going to take about a third of the company in exchange for his or her money.  Since the investment you – as the business seller – are looking for is $2M, that 2-million dollars is ‘about a third ‘ of … $6M.  Your nascent company has just been valued at $6M.

 

Note: This 50% return on investment isn’t nearly as arbitrary as it might sound.  It’s called the Discount Rate – and it’s a reflection of the risk involved.  Placing money on nothing more than a bright idea is extremely risky.  Placing that same bet on a company that’s already successful and is expanding – dramatically less so.  There are rules of thumb for discount rates:

Seed stage: 80%+

Startup: 50-70%

First-Stage: 40-60%

Second-Stage: 30-50%

Bridge/Mezzanine: 20-35%

Public Expectations: 15-25%

 

the 30-second approach to finding out how much your business is worth

Rules-of-thumb have the nasty habit of being used for so long that we start to think they’re more than rough guides, that they are, indeed, shortcuts to avoiding real work. And so it is with a whole lot of ‘back of the envelope’ approaches to figuring out how much a business is worth.

With this bit of foot shuffling, the fastest way to get a v-e-r-y rough business evaluation is by way of ‘multiples.’

We’ve gotten used to hearing about multiples in stock market reports: such and such a stock is running at 20-times earnings. Investment real estate is another place where multiples get a lot of press: the rule of thumb being commercial real estate sells for about 8-to-10 times the amount of income it generates.

There’s a great article by Glen Cooper in BizBuySell about Valuation Rules of Thumb. (anything I get right here is because of his article, anything wrong – mine entirely). http://www.bizbuysell.com/guide/b_value_1.htm

OK, I promised 30 seconds. Here it is.
1. You need to conjure up what you think NEXT year’s earnings from the business will be. These are real earnings – not the smallest possible number that the IRS encourages us to send in every year — earnings without those padded expense accounts, those magazine subscriptions, those business junkets to Must-Attend industry conferences (in Maui, in February…). In the jargon, projected ‘normalized earnings.’

2. Take this dollar amount .. AND MULTIPLY IT BY 3 or 4 or 5. That’s it!

I’ll spare you the obligatory shuck-and-jive about how this is only a very, very crude approach – but do take all these guides with a grain of salt and a little chuckle. That said, it is a frequently used rule of thumb. And it starts to give you an idea about valuation.

Why a 3-to-5 multiple?
-Well, if you buy a company for 3-times its earnings, it’s gonna take you 3 years of ownership til you get your money back. And – very very simplistically – after that, ‘the money is *yours*’. In numbers – your return-on-investment is 33%.
-If the multiple is 5 – you’ll wait 5 years to get your money back — an annual ROI of 20%.

Now – a 20% return on any investment is pretty darned good. 33% even better. The point is, the appeal of this kind of return makes a company being sold a very tempting offer.

And anyway, it’s also a cool way to spend 30 seconds …

so, how much is your business worth these days?

There are lots of ways to do valuation – from the rigourous  bring-in-the-accountants approach to the back-of-the-envelope scribbling based on revenue and a bit of Kentucky Windage.  And, predictably enough, a whole lot of free (or inexpensive) software tools to walk you through a process.

In this last group is the (free) valuation service provided by BizTrader. ( http://www.biztrader.com/valuations/financial )  

4 clumps of data need to be entered:  contact info, P&L (revenue net income, owner’s compensation), Balance Sheets (assets, liabilities) and Qualitative Risk Assessment.  15 or 20 minutes work and you get back a report that gives you, at the very least, a solid estimate.  For less than a half hour of work, a pretty good deal!