Determining the Value of Your Business Requires a Balanced Perspective
Establishing the value of your business investments can be difficult. While well-known valuation methods can give you a rough idea, ultimately your business is only worth what someone is prepared to pay for it.
In 2001, there were over 1,000 public offerings. Few flourished and several lost much of their value or went out of business. The culprit seems to have been excessive forecasts and losses in addition to a decline in the economy and tech forecasts. Greed among many of the participants, including prominent venture capital and investment banking firms, was also a significant factor. As a result, there were few new issues in 2022 and they are only now starting up again in 2023.
In contrast, there are over 1 million new small business startups since the pandemic. While many have achieved their goals, a significant number of them never really became significant or will exit the market within 5 years. These are mostly individual or small entrepreneurial efforts with expectations of less than a few hundred thousand dollars in volume. Their goal is to provide income, growth, and a better lifestyle for the entrepreneur.
These differences illustrate the need to understand goals and parameters when analyzing the value of your business or stock. For example, retirees building a nest egg for their heirs have quite different perspectives from families who need their wealth to fund their own retirement. Additionally, much of our country’s wealth is concentrated in 5-10% of our population. Thus, in 2002, much of the tech stock decline had minimal impact on wealthy individuals while affecting the income of retirees with investments of less than $100,000.
A critical and frequently overlooked factor in evaluating investments is risk. Investors seem to be willing to take higher risks in order to get higher returns. Much of the debacle with the 2001 new issues was due to funding extreme forecasts with high risks. Venture capital firms do mitigate some of the risk by funding many deals and only needing a few successes. In contrast, most individuals are more risk averse, especially people planning retirement.
Tools and criteria to evaluate businesses greatly affect valuations as well. Long-term versus short-term, fixed versus variable streams of income, risk, growth versus income, and earnings can all affect perspectives. Just consider the variations in value between your home, a fixed pension, and tech stocks.
Special features like skilled employees, intellectual property or other special strengths of your business can increase investment value. A few years ago, “tech” was almost holy as an investment. Basic industries like autos, housing, retail, and utilities may have significant fluctuation as they are experiencing little long-term growth. In contrast, A.I. and electric cars seem to be the major hot industries today.
There are several standard techniques that can be used to provide a benchmark to determine the value of your business investments. Using different valuation methods can help you come up with a range of valuations for your business. Values are also affected by social, economic, and psychological environments. For example, values of sports teams have experienced unimaginable growth because of the desires and wealth of many billionaires.
Measures like P.E., present value and discounted cash flow are generally considered the standard for evaluating investments. One of the advantages is they can be analyzed to consider factors like annualized returns in order to compare investments. For example, growth companies will expect higher P.E.’s than stable companies.
Profits and cash are critical factors in evaluation particularly for small entrepreneurial companies. These measures need to be mitigated by benefits, taxes, and investments not apparent in cash benefits. For example, a significant advantage of many tech companies is the minimal investment aside from people and marketing. Thus buildings, factories, equipment etc. are not required. Even manufacturing is frequently contracted out to reduce investment and provide cheaper sourcing. Many public companies have also modified disbursements to owners. In particular, stock buy backs rather than dividends allow more flexibility and tax benefits.
The value of assets and liabilities in your investment is a critical factor in your valuation. These values can be significantly different from book value and need to be considered Real Estate valuations, and the ability to borrow money at reasonable interest rates is a critical consideration.
Startup or entry costs are also significant aspects of valuation. The valuation includes the costs of purchasing assets, developing products or services, recruiting and training staff, and building up a customer base. For example, a pharmaceutical company might want to choose between buying a biotechnology business and investing more in its own research and development operations.
Different industries also have their own rules of thumb that can be used to calculate a value of your business. For example, many retail businesses are valued as a multiple of turnover. Other common valuation methods are based on the number of customers, clicks, or the number of outlets. Industry rules of thumb like these are often used in sectors were buying and selling of businesses is common.
In summary, valuing your business and investments involves a number of considerations. What are your goals, constraints, risk levels, and alternatives? Plan ahead – the more time you have, the easier it will be to show your business in the best possible light. Sort out systems – strong management information and operating systems give the purchaser confidence that there won’t be any unpleasant surprises. Structure the transaction to maximize the price, process, and requirements. Consider issues like taxes, timing, and operations that can have an impact.
Dr. Bert Shlensky, president of Startup Connection, prides himself on his ability to define what is unique about each and every business. He works closely with individuals to develop a personalized approach that targets specific areas of concern and offers solutions based on his 40+ years of experience. His team of experts will address your particular needs while working to save you time and money.
You can reach Dr. Shlensky at: 914-632-6977
Or email: bshlensky@startupconnection.net