Champagne for everyone. For my inaugural Inc.com column, I've chosen a feisty topic... Valuation.
Valuation is a nasty job, but somebody's got to do it. Accepted methodologies tend to be old and dogmatic. As with 'The Emperor's New Clothes', most people fail to see the obvious, while others find safety in being loyal to the Emperor.
First, some context. Who wants your valuation and what is it being used for: Funding, Credit Line or Acquisition? As we mostly work with companies who are fast-growth startups in technology or innovation, they are either fundraising or building to an exit. These days, being acquired is statistically the most likely 'good-exit' strategy. I'm not saying this should be your only goal; just that it might be the ultimate way to satisfy shareholders. So, if your team doesn't already know about IPO's, don't count on it! Under $100 million acquisitions are more common, since for the billion-dollar acquiring company, it's a fast way to build assets.
'Acquiring' companies are always fighting for top-line growth, so their primary need is to find hot new revenue sources. Even if they over-pay, say $60 million for something worth $40 million, they expect to be able to turn it into a successful operating unit, and build to $100+ million in revenue. Even if the acquiree wasn't profitable, they'll use their operational acumen to fix that. I have seen this in acquisitions I've been part of. We sold Knowledge Adventure in 1996 for $100 million. By 2000, Universal Studios built annual revenues to $400 million. Conceivably then worth a billion dollars! Lesson: Forget EBITDA, think Revenues.
Traditional methodologies taught in B-Schools and MBA programs to value businesses include Income, Market and Asset-Based approaches. You can select variations based on the facts and circumstances of your company, and availability of information. Investors and advisors love data, especially when it shows how they account for risk. While these traditional analyses are nice to have in-hand ... YOU can do better! Two things matter more than anything: 1) Your Company's sales trajectories and 2) Finding 'Comps' (industry standards) with other good companies.
Others may disagree, but revenue growth matters most, not big profits. When I see profits, I wonder what stopped them from pushing revenues higher? Due to the Acquirer's needs, your company will mostly get valued as a multiple of revenue. For tech companies, 2-5 times revenue is a good place to start. For truly amazing tech companies, it might hit 10-20 times revenue. You move higher or lower within these multiple ranges based on the excitement of your sector, the economic and competitive factors, timing, and market issues.
'Comps' Rule. Like real estate, if the house next door is worth a million dollars, and yours is identical, then it's worth the same. If yours has a pool, add something. If your backyard is bigger, add more. Just substitute the word company for house here. It's tougher when there is no 'house' for direct comparison. Then, you will need to take the closest house (company) you can find and hypothecate how long it will take yours to be as good as the 'comp', perhaps by discounting your value by 15% for each year it will take?
Other tricky issues. Don't have revenue yet? Develop a solid forecast then discount back to allow for any delays and risks. (Failing that, there's usually a commonly accepted local valuation for pre-revenue start-ups, these days in the $2-5 million range.) Should you have multiple investors or suitors? Yes, but try to have them come in individually. They get too friendly if you introduce them.
P.S. It's always best to have someone advise you on valuation. Like judging your own child, it helps to have someone to talk sense with you.