The Winning M&A Advisor [Vol. 1, Issue 3]
Welcome to the 3rd issue of the Winning M&A Advisor, the Axial publication that anonymously unpacks data, fees, and terms…
“How much is my business worth?” I’ve met with many business owners from all walks of life over the course of my career, and almost without exception — whether they are a founder looking to finally realize the monetary reward from their life’s work or a private equity professional preparing to sell the twenty-first portfolio company of her career — they always pose this question first.
It’s an important question, but also one without an easy answer. Business valuation is both a highly sensitive and highly subjective topic.
You will hear many responses to the question of what a business is worth. One oft-quoted answer is “a business is worth exactly what a knowledgeable, willing, and unpressured buyer would pay to a knowledgeable, willing, and unpressured seller in the open market.” This adage is technically accurate but extremely unhelpful. It is tough for any business owner to put their finger on what exact figure that formula yields.
And so, we move beyond the theoretical into the land of the more practical. Below are the top quantitative and qualitative valuation models used today, but (spoiler alert!) none of them is the correct answer.
Liquidation is certainly not a fun situation to contemplate, , but every business has a liquidation value. Simply put, if you closed down tomorrow, how much money could you squeeze out of the business? You’d auction off your fixed assets, hold a fire sale on inventory, give discounts to immediately collect as many accounts receivable as possible, and then pay off your vendors, employees, and other business obligations.
For a well-performing business, this would be the lowest valuation possible, only to be considered as a last resort. For a distressed business that is losing money, this may be as good as it gets.
Book value, or shareholders’ equity, can be found on any company’s balance sheet and is another potential valuation indicator. This will yield a higher result than liquidation value, as assets are not discounted. However, it is still an asset-based valuation technique, and therefore will typically be more conservative than the earnings-based approaches discussed next. And if your fixed assets are more valuable than their depreciated value (as they most often are), then book value will be even less attractive.
Book value is rarely used for well-performing businesses, as the earnings that those businesses generate should support a higher valuation than the book value of the underlying assets.
Ask any investment banking analyst how to value a business, and they will lapse into a rote recitation of the Big Four Valuation Models. Though the specific names may vary from firm to firm, the standard earnings-based valuation models used by all investment banks are:
Investment bankers then take the output from each of these four models and blend them with different weightings to yield an overall valuation range. If the buyer is likely to be a publicly traded company, they also might throw in a fifth model, the Accretion/Dilution model, which looks at how the acquisition (at a given valuation) impacts the acquirer’s Earnings Per Share (EPS). Between the assumptions inherent in each model and the various ways they are often blended together, the final valuation range is definitely more art than science.
If all of those quantitative valuation techniques don’t already have your head spinning, there are more. While many qualitative factors can have a significant impact on whether your business lands at the upper or the lower end of a computed valuation range, four stand out as most influential:
But here’s the dirty little secret that no one talks about — valuation ultimately isn’t about rational techniques at all.
Sure, most buyers begin by running some of the aforementioned valuation models. But when it comes to how much extra the most aggressive buyer is willing to pay for your business, only two things really matter: competition and personal intangibles. These two factors work hand-in-hand.
Setting the hook in a buyer is easier said than done, but once accomplished, you can push buyers to bid against each other to attain valuations unsubstantiated by any model.
Ultimately, it is human emotions that drive one buyer to pay more than all other buyers. Examples include:
There’s no simple answer to the question of how much a business is worth. Models mixed with your advisor’s experience are used to approximate what a “reasonably aggressive” buyer would pay for your business in the current market, and this is a valuable data point when deciding whether to sell your business. But there’s no predicting what specific factors will ultimately drive one or more buyers to be irrationally aggressive. The key is to present the acquisition opportunity in the best light and create as much competition as possible. That, in a nutshell, is what a good investment banker will do for you.