Valuing a Business

[SQolar]

How do you value a company or a business? How then will you value the shares (or investment) of a potential investors who would like to invest in your company?

[cyman]

Depends heavily on the industry.
A web-based company, as a yardstick, sells for 1X-2X annual revenue. If there is serious intellectual property, then it could be more.

There's a big difference between a sale and an investment. With a sale, there is a lot more risk for the buyer, since the guy who knows the business best is jumping ship or no longer involved.
With an investment, so far as I heard from the vets around here, if you can make a good case that you will grow or sell for more, you can do it.

[akula]

How do you value a company or a business? How then will you value the shares (or investment) of a potential investors who would like to invest in your company?

welcome..well...this is either extremely, extremely complicated (i.e. pro formas, DCF, WACC, beta, P/E etc)....or extremely, extremely easy

in my experience, investors like to keep things very simple, so this is how the valuation is normally done (it's a 7 step process):

1. The investor identifies how much money they have to spend (i.e. $100)
2. The investor identifies their time horizon (i.e. 5 years)
3. The investor identifies their hurdle rate (i.e. 30%)

With this in mind, the investor will invest $100 and has to sell his stake for $370 within 5 years (i.e. 100x(1.3)^5) to meet their 30% annual hurdle rate..and out of these metrics, the premoney valuation gets worked out

e.g.

4. if we think we can sell the firm in 5 years for $1000, what is the required valuation for the company now?
5. discount the $1000 by 30% for 5 years, so the current post money valuation is $270 (i.e. 1000x(1.3)^-5).
6. If the post money valuation is $270, and I invest $100 what is the premoney valuation? It's $170 (i.e. 270-100).
7. If the premoney valuation is $170 and I invest $100 how many shares do I get. It's 37% (i.e. 100/270)

and that's how valuations are done in the industry...it basically says that "I have $100 to invest, I want to sell this stake for $370 in 5 years time, I think that we can sell this firm for $1000 in 5 years, and with these numbers, I'll have to value your company at $170 and you will have to sell me 37% of your stock...so that when we exit for $1000 I get my $370.")

...and then negotiations start and people push numbers backwards and forwards to adjust the premoney, the hurdle rate and other metrics..

most importantly, as you can see, the valuation has nothing to do with how many customers you have, what your expenses are, the kinds of assets you have, what your industry is or anything else that relates to your business. in reality, the valuation is defined by unrelated items like how much money everyone has, how much they wanna make, and how quickly they wanna make it

[biatris1]

Valuing a business is difficult… yet very simple. Simply, your business is worth exactly what a buyer will pay for it. Usually a business’ value is determined by a multiple of their EBITDA (Earnings before Interest, Taxes, Depreciation & Amortization). EBITDA is a measurement of cash flow.

To clarify: Let’s say you own a distribution business that does five million a year, and your EBITDA is five hundred thousand. Right now distribution companies are selling anywhere between two to four times EBITDA. That’s a range from one to two million you can expect to sell your company for.

If the seller of a company prepares himself properly an investor will not think of him as jumping ship. By creatively structuring a deal a seller can create confidence in their buyer. It’s typical for a seller to sign an employment agreement for anywhere between one to five years. A confidence building term of the deal could include partial payment of the purchase price be paid as an earn out.

Hope this helps

Alana Sotelo
Aegis Bancorp
Bakersfield, CA