What’s my business worth? That’s a question every business owner has asked themselves at some point. Investors can value your business in a myriad of ways, but there are certain methods that will be used often. It’s important for you to have a general understanding of them as you try to raise capital or sell your business. As you’ll see, valuation is sometimes as much art as it is science, and that can lead to a lot of interpretation and negotiation when it comes down to getting full value for your business.
A. Discounted Cash Flow (DCF) Method
The DCF method is based on the concept that the only thing of value about your business is its ability to generate cash into the future. The DCF method considers the future free cash flows from a business and applies the time value of money concept to arrive at a present value for all of a business’s future cash flows.
There are a lot of assumptions that go into the DCF method. The first is future free cash flows. Anyone building cash flow projections must have an understanding of your business’s products or services and their growth potential to have a reasonable chance of accurately predicting this. These cash flows are usually predicted for at least the next five years. The second assumption to make when using this valuation method is when you believe your business will reach maturity. This is where little to no growth beyond normalized GDP growth is expected to occur. All businesses reach maturity at some point, and after determining when this will be for your company, you can calculate the terminal value. This single calculation replaces the need to continue calculating yearly free cash flows. Once the terminal value is calculated, it is then discounted back to the present along with each yearly cash flow that was previously calculated. Discounting these numbers involves, of course, a discount rate, which is the third major assumption that is required in the DCF method. Calculating the discount rate entails predicting future interest rates and the capital structure of your business. With these assumptions, you can sum together the discounted cash flows and terminal value to arrive at one single present value. That present value is what your business is worth today according to the DCF method.
B. Precedent Transactions
Valuation of a business by comparison of precedent transactions involve the analysis of previous transactions with acquisition targets similar to the business that is for sale now. If there are enough acquisitions with enough similar characteristics taking place in the market, it stands to reason that the value placed on those targets can be used to value your business.
A frequent limitation of this valuation method is that there often are not enough transactions taking place or made public to provide a good idea how to value one’s company, especially if the company is in the middle to lower market. You can use a small handful of precedent transactions to value your business, but understand that the true valuation (what the market is willing to pay) could be very different.
C. Public Comparables
Valuing a company with public comparables has to do with placing a value on a business based on what the market is valuing similar, publicly-traded companies. Like precedent transactions, that can be difficult to do for middle to lower market companies, because there are not likely to be many public comparables from which to choose. This method requires using best judgment based on revenues, assets, debts, cash flows, operations, and products and services.
For additional reading, we recommend two books by the guru of valuations, Aswath Damodaran: “The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses” or his now-mature classic “Investment Valuation: Tools and Techniques for Determining the Value of Any Asset”.
Aethlon Capital is a Minnesota-based investment bank with decades of experience assisting business owners in raising capital and selling their businesses. We help owners develop the necessary steps to facilitate corporate growth and align with strategic partners. Aethlon has completed mergers and acquisitions in numerous industries – from consumer products to construction, and from luxury goods to high technology.
Our professionals would enjoy the opportunity to discuss your company’s growth plan. To find out how Aethlon’s investment banking services can help you, call Sima Griffith at 612.338.6065 or email firstname.lastname@example.org.