Why it makes good business sense to get a feel for the equity value in your business

09 April 2018

Goals are naturally focused around growth and profitability 

Most entrepreneurs work long and hard to achieve their business objectives. We see most goals are naturally focused around growth percentages, level of profitability, market share, international footprint and many more such parameters.

However, many entrepreneurs never pause to check on the equity value growth in their business. It’s like working hard, saving some money every month and year but never checking on the growth of your money in the bank. Now, it’s obviously far easier to take a quick look at what you personally have saved up to a certain timeframe than it is to calculate or even estimate the value of the equity in your business. Simply put, it is not a trivial matter.

Shareholders rely on a 'gut feeling' of their business' equity value

Most of the shareholders and company owners we meet with only have a ‘gut feeling’ of their business’ equity value. This is generally based upon multiples of their revenue and profits and by comparison with other organizations (in the software sector). However, by way of analogy, if two houses that look similar on the outside have a completely different kitchen, bathroom and layout, one with a luxury interior, the other, a ‘bargain basement’ interior, this is not something that can be easily detected from the outside.

It’s what we call the “myth of the multiples”. We have published a number of articles on this topic. In a nutshell, comparing multiples of revenue to calculate business valuations can be highly misleading. We have had situations where we have achieved in excess of 6x revenue for a client. On occasions, the big software moguls such as Google, Facebook and others, pay enormous valuations for sometimes relatively small companies.

Two distinct factors influence the potential valuation of a company:

  1. Single tree versus a forest of trees
    Firstly, and probably most importantly, is your business a ‘tree’ like many others in the same forest or, are you standing just outside the forest, uniquely positioned with no comparable trees anywhere close by.
    If you are a good-looking tree in the middle of a forest with apparently similar trees all around you, then any acquirer will have a large choice of businesses (trees) and may target multiple companies instead of looking only at your business. If your company’s story stands out from the crowd and you have unique positioning, then there is no alternative!
  2. A 5-year plan:
    The other element to consider, is that no buyer will acquire based solely on past performance. It is essential to have a coherent plan with at least a 5-year forecast, which includes evidence to substantiate why the projections are realistic and how they will be achieved. This is crucial to enabling a buyer to calculate their business case and how they envision their return on investment, mostly by using the common DCF (Discounted Cashflow) calculation.

Creating a 5-year plan forces deep thinking around all the key parameters of your business, such as your:

  • Competitive position and how you envision this developing in the future.
  • Your marketing capacity to build the story that stands out and shines
  • The marketing execution that delivers the proof by providing exactly the number of leads or traction backed up by impressive conversion rates.
  • Polishing and positioning your hidden assets (elements of your business you take for granted but are of high value for buyers).
  • The engine that fuels your business - meaning your sales. Can your current sales force keep up with all new developments or are they dinosaurs, remaining stuck in the past?
  • Have you ensured that your management team is aligned, shares the same objectives and has a clear understanding of how the business should be developed?

A 5-year strategy, combined with a clear vision of how to bring it to fruition, is the right foundation from which to assess your real assets and prepare a solid Business Valuation. Such valuation assessments we undertake for our clients have proven to be a powerful tool in negotiations with potential buyers.

Completing the circle for the entrepreneur

At this point, let’s also not ignore, that, for many business owners, completing the sale of their business at a certain point means, ’closes the circle’. One of our clients recently stated: “The fact that I managed to successfully sell my business, completed me as an entrepreneur.” -  He was also free to do it over again, based on the lessons learned.

So, where does this bring us in assessing equity value and what to do with a business valuation assessment? If all key aspects are brought into alignment and improvements implemented, it makes good sense to develop a complete DCF-based (Discounted Cashflow) equity value calculation. Based on the current FY and last FY you can then assess whether you are in-line with comparable transactions, because your (DCF) calculation will be based on your business projections.

Don't overlook the value of synergy 

And finally, a ‘sensitivity analysis' completes the picture. Such a calculation forms the basis for any negotiation with a potential buyer, in case they make a lower bid than expected. It focusses the debate on which parameters they have used but above all, steers the conversation in the direction of the synergies included on top of the projections we help our client to produce.

We are cautious in sharing this information with prospective buyers, too easily or too early in the process but, it enables our clients to gain a good insight into the potential of their business. As a further positive, the entire exercise stimulates a lot of thinking around the different growth and investment scenarios and which aspects of a business really matter for equity development, as opposed to being simple business growth parameters.

If you’d like to get a feel for the equity value and the potential assets within your business, don’t hesitate to reach out to us.

Thank you.

Geert Kruiter
SVP, Europe – Boss Equity