Price & Valuation = Art + Science – Science-Fiction
Those of us finance professionals who’ve been toiling in our cubicles for decades, learning the sacred principles associated with ascribing value to a company, believe that valuation is both art and science. Taking the purely academic approach and relying on analytical outputs from your operating model is just the beginning of the journey.
Businesses, in a legal and practical sense, are viewed as persons and unless your company is severely distressed or a rarely seen unicorn we should approach its intrinsic value with a healthy degree of respect. What is your business worth?
This question often elicits emotional responses from entrepreneurs who feel their businesses are worth far more than they actually are. I once asked the owner of a business with N50 million in revenues why he thought his company justified a $7 million valuation tag and we were immediately transported to a badly scripted science-fiction movie. Long on fluff and indemonstrable future value and short on facts and rigorous analysis.
When your business gets to the stage where private and/or public equity capital providers are interested in investing, you need to have a solid basis for the answer to this question and it shouldn’t be an unjustifiable number in hard-currency. You are essentially communicating to your prospective investors that you are unreasonable and the negotiations will be arduous. Getting to the right valuation is a multi-step process involving a plethora of financial, industry, and macroeconomic data, which without, it’ll be almost impossible to arrive at a price that everyone can agree to. It’s important to understand that price and valuation are not the same thing. When an investor asks you what your company is worth, (s)he is trying to establish the price that (s)he will need to pay for a stake in your company. Creating fancy valuation models, which investment bankers are highly skilled at (myself included), is just one step in the process of determining your company’s value. Once you have utilized the industry accepted methodologies, you would have arrived at a valuation range but price is where the dance becomes very delicate. Price has several determinants that could be driven by the terms and conditions of the share purchase agreement, stake being acquired (minority vs majority), ownership of key intellectual property rights, governance considerations such as board seats, earn outs, etc. Each issue affects price in a way that has nothing to do with the underlying company valuation. And price, my dear friends, is what dictates your new bank balance after the transaction NOT valuation.
Once you’ve deeply analyzed your historical financials (which I hope have been audited by a suitable accounting firm), you will rely on those fundamental trends to project where your business will go in 5 – 10 years and beyond. This is where the interplay between Art and Science goes into full gear. You can’t be unrealistic although you should be aspirational and only you can sell that story effectively because you have lived and breathed the company. Don’t be shy to ask for a price that incorporates your hard work but it’s got to make sense or you’ll turn buyers away.
If you’re a company that has been in operation for a number of years with an established business model having recorded revenue growth over a sustained period, a track record of operating profit (I hope), and ambitions to scale, this note is for you. Email me. Scale is the name of the game and if you’re not interested in playing, that’s fine too. I guess. For those who want to sell their businesses for significant multiples of its earnings you should be living and breathing growth; new markets, new products, new ideas, new partnerships, new distribution channels, more economies of scale and all that fun stuff. All of these preceding aspirations will ultimately drive the worth/valuation of your company and the price that an investor is willing to pay for it.
This article was published in Business Day, online and print, and may be found at https://www.businessdayonline.com/price-valuation-art-science-science-fiction/
