The question is, how is it done?
Arguments rage as to whether business valuation is a hard-and-fast science, with a formula that can be rolled out repeatedly, or more of an art, requiring creative thinking and a keen sense of the nuances of this particular business. As is so often the case, the truth is somewhere in between – we’d argue that if the science comes first, then the art can follow afterwards.
First steps: hard metrics
Many different methodologies are used to value private businesses based on hard figures. You might use a multiple of earnings or profits. You might use a multiple of sales revenues. For businesses that have already undergone an investment round, you might start there and calculate a ‘life’ based on milestones achieved since.
The point is, there are many different methodologies to choose from, and the right model – or, more likely, combination of models – for your business is going to depend on – well – your business. However, almost every methodology will consider three core factors. First – the business’s free cash flow. That is, how much revenue it generates today. Second – the business’s cost of capital. That is, the rate it has to pay on any capital it has already raised. And third – expected growth. This one, of course, is self-explanatory.
Collectively, these factors give a picture of the business’s current health and projected future, which need to be considered together in order to value the organisation.
Second steps: the art of positioning and weighting
This is where the art of business valuation comes in. Buyers and sellers of businesses obviously have their own motivations when it comes to valuing businesses, and with such an array of methodologies to choose from and combine, it is important to choose the ones that best support your goals. Equally, it is important to be able to understand how an opposing party may be picking and choosing methodologies to support their goals.
Business valuation, in other words, intersects and overlaps heavily with deal strategy, and the key goal for you as a business owner is to create the situation which gives you the most leverage possible.
Another aspect of the art of business valuation is being as concrete and tangible as possible when it comes to choosing and presenting core metrics. The more precise you can be about projected earnings for example – which in turn, means being able to clearly explain how you have arrived at those projected earnings, the more confidence you will build in your business valuation.
Business valuation is a future-gazing exercise
Ultimately, any business valuation is attempting to pin down how successful that business is likely to be in the future. And of course, future-gazing is something that can never be done with total accuracy or certainty. Business valuation relies on a combination of hard metrics, concrete and comprehensive figures and clear methodologies – and a thoughtful approach to how those metrics are combined, presented, and justified. There is both a science and an art to valuing a private business.