How to determine the value of a company?
As an entrepreneur you are – as a matter of course – occupied with the future of your company. What are the opportunities in the market for your branch? Where do you want to grow with your company? And when you eventually want to sell your company, how much is your company worth? Smart entrepreneurs have been developing their most important value drivers for years before selling their company. The value drivers are in fact the most decisive factors for the value and price of your company, not just profit or EBITDA.
In this blog you will read which factors determine the price of your company, how this value is determined and how you can anticipate this in time for the best deal price as an end result.
Determining the value of your company: cash flows, business model and risks
First of all, let’s say that determining the asking price of your company is not an exact science. Nor is it an accounting sum of numbers on the balance sheet and in the profit and loss account. So what is it based on?
The basis for the value of a company is its cash generating capacity. And not profits. A company that, in addition to depreciation, also has to invest the profit each year in new machinery and stock has no value in the perspective of constant exploitation.
To calculate the value, we use the so-called Discounted Cash Flow (DCF) Method, by which future cash flows, taking into account the risk profile of the company, lead to the value outcome. In the assessment of future cash flows and risk profile, the quality of the business model plays an important role. The following aspects spring to mind:
- Is your business model based on hours or products?
- Does your company have long-term contracts?
- What is the Customer Lifetime Value of your customers?
- What are the market developments in your sector?
- To what extent is your business scalable with a view to the future?
- What are specific risks and dependencies?
- What development opportunities has the company developed for the future?
These are partly subjective assessments that may be judged differently by a buyer. This difference in assessment can cause a discrepancy between your personal perception of a price and the perception of the potential buyers. Our experience shows that more than half of the entrepreneurs overestimate the value of their business. With the help of an acquisition specialist, you can formulate a realistic and market-based price range in proper consultation.
That many times EBITDA?
In offers and negotiations the price is often expressed in ‘so many times the EBITDA’, also called a multiple in the takeover world. The Multiple is therefore the denominator by which EBITDA is multiplied to arrive at the rough company valuation. For a Multiple of 6 with an EBITDA of €1.5 million the enterprise value is thus around €9 million. Multiples are derived from databases of comparable transactions, but in practice not enough is known about the transactions to make a proper comparison: were the circumstances similar? Was the buyer comparable? Is the company really comparable to the company in this transaction? Multiples are company and transaction specific and companies are difficult to compare. The EBITDA method takes too little account of company-specific factors. For example, a relatively small software company in a fast-growing market can easily be worth 10 to 15 times the EBITDA. And for a larger company with fewer growth opportunities, a lower Multiple of 4 to 5 might just apply.
In addition, the EBITDA is not useful in many industries, for example companies with high investment needs, where EBITDA is reduced by investments.
EBITDA is therefore too imprecise for a good value indication, but in some cases it can be used as a rule of thumb.
Dealbreakers and price reducers with negative effect on the sales price
Dealbreakers are issues that can frustrate negotiations. Examples are the right of a major customer to terminate the contract in the event of a change of ownership, a patent infringement or the absence of a non-competition clause in the case of some key employees. Our experience shows that this does happen often.
Price reducers are elements that weigh heavily on the side of potential buyers when considering the price. They include, for example, the high degree of dependence on a few important customers. Or the inability of the buyer to deliver critical business data due to poorly designed systems. But of course, the unexpected deterioration of business results during the sales process can also be a deal-breaker.
Influencing the value of your company yourself?
As an entrepreneur, you would do well to start thinking in good time about value drivers, dealbreakers and price reducers. A complete insight into these factors is the first step towards preparing your company for sale.
Discover how you can influence the valuation of your company here the E-book (in Dutch).
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