When entering into a business valuation discussion, ensure that you understand the key terms related to business valuation i.e. financial jargon.

Definitions of value

There are different definitions of value. They are used for different purposes. To make things more complex, different organizations may have different perspectives on what a given definition of value means.

‍

- Fair Market Value: the price at which as asset would change hands between a willing and informed buyer and willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.

- Intrinsic value: The intrinsic value of an asset is its value given a hypothetically complete understanding of the asset's investment characteristics.

- Investment value: is the value to a particular investor based on this investor's investment requirements and expectations.

‍

Additionally, some key terms to understand include:

- Pre-Money Valuation: the value of the company prior to the investment

- Post-Money Valuation: the value of the company following the investment

- Amount Invested: the price the investor will pay to realize a return.

‍

The Pre-Money Valuation and the Amount Invested determine the “Investor’s Ownership Percentage”.

The following formula is applicable:

‍

Equity owned by investor (%) =

Amount Invested / [Pre-Money Valuation + Amount Invested]

‍

‍

Methods of Business Valuation

Under each approach, a number of methods are available which can be used to determine the value of a business enterprise. Each business valuation method uses a specific procedure to calculate the business value.

No one business valuation approach or method is definitive. Hence, it is common practice to use a number of business valuation methods under each approach. The business value then is determined by reconciling the results obtained from the selected methods. Typically, a weight is assigned to the result of each business valuation method. Finally, the sum of the weighted results is used to determine the value of the subject business. This process of concluding the business value is referred to as the business value synthesis.

There are three fundamental ways to measure the value of a business:

1. Income approach

The returns are estimated as either a single value or a stream of income expected to be received by the business owners in the future. The risk is then quantified by means of the so-called capitalization or discount rates.

The methods include:

- Discounted cash flow method

- Capitalized earnings or cash flows method

2. Market multiple approach

One consults the marketplace for indications of business value. Most commonly, sales of similar businesses are studied to collect comparative evidence that can be used to estimate the value of the subject business. This approach uses the economic principle of competition which seeks to estimate the value of a business in comparison to similar businesses whose value has been recently established by the market.

The methods include:

- Comparative private company transaction method – Guideline Transaction Method (“GTM method”)

- Comparative publicly traded company transaction method – Guideline Public Company method (“GPC method”)

3 Asset approach

Focuses on a company's net asset value (NAV), or the fair market value of its total assets minus its total liabilities, to determine what it would cost to recreate the business.

The methods include:

- Adjusted Net Asset Value Approach

- Liquidation Approach

Key Considerations for the above-mentioned valuation methods:

Income approach

Application:

- Going concern

- Finite life assets

Routinely used when:

- Forecasts are available
‍

Market Multiple Approach

Application:

- Going concern

Routinely used when:

- Suitable comparable companies/ transactions exist

- Cash flow forecasts are not available

- Corroboration
‍

Asset Approach

Application:

- Real Estate / Banks

- Non-going concern i.e., liquidation scenarios

Routinely used in:

- Mark-to-market sectors like banks and real estate

How to maximize your valuation:

- Make a good case. Show the investor why there is huge potential exit value for your company.

- Maximize the potential exit valuation by removing any doubt or obstacle that the investor perceives as limiting the upside valuation.

- Do your homework. Understand the valuations of other companies at slightly later stages. Identify and understand the gaps (technical or commercial) between your business and theirs. Then, focus your company’s business plan on closing these gaps.

- Find an investment competitor. If there is competition for your deal, an investor will be more likely to give you a higher valuation.

In conclusion, when going through the business valuation process with an investor, consider the below tips:

- When you are first given a valuation, ask for a higher valuation. Pushing back demonstrates that you’re confident in your business and a good negotiator.

- Take the money and get to work if the valuation is reasonable. Neither the valuation nor the investor’s specific percentage will significantly affect the company’s ultimate success.

- Talk to your advisors, board members, consultants and other industry players to determine if the deal you’re getting reflects current valuations.

- Consider taking a lower valuation from the “better” investor, if you think that one investor brings more to the table than another.