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3 Methods for Valuing Your Business

You’ve decided to sell your business, and one of the things on the top of your mind is naturally valuation. You’ve hired a banker or advisor and they’ve come back with an estimated valuation range that just isn’t want you were expecting. So how did your bankers arrive at their unsatisfactorily low conclusion – isn’t valuation as simple as applying a relevant revenue, EBITDA, or free cash-flow multiple to your business?

While multiples are a common shortcut for valuation, conducting a thorough valuation is much more complex than slapping a multiple on an income statement line item. Determining the value of a business can be an opaque and somewhat subjective process. So, how exactly, then, does a banker go about approximating what a business is really worth?

Any banker worth her salt is going to start a valuation exercise by utilizing multiple methods to narrow in on the right number range. There’s more than one way to value a company, and no one method is more accurate than any other. While intuitively it makes sense that all valuation paths lead to the same end result, the reality is that once the numbers have been crunched, a banker is most likely going to end up with a handful of independent, estimated values for a business.

Here’s where the real work begins: looking carefully at the ranges of valuation that your different methods have produced and using qualitative, subjective insight to distill your various valuation estimates into a single range that makes sense. For each method of valuation, a banker is going to consider a variety of non-quantitative factors and adjust the valuation accordingly.

Let’s look at some of the primary considerations a banker will review when it comes to some of the most common valuation methodologies:

Discounted Cash Flow (DCF)

If bankers had a crystal ball into the future, DCFs would be a great way to value a business. Instead, DCFs involve a huge amount of discretion in projecting what a company’s business will look like for the next 5-10 years. Operational assumptions for the model are typically provided by a company’s management team, so a banker needs to consider that the validity of the data (and therefore the valuation) will heavily rely on management’s ability to accurately predict the future.

Most buyers, as they start to negotiate with you, are going to attack many of the assumptions you’ve made about future growth. By helping your banker understand which line items are highly predictable and which you believe are more variable, you’ll be able to get a better valuation for your business and help them in negotiation with a buyer.

Trading Comparables

Most bankers typically love using trading comp multiples to determine valuation because they reflect real-time, real-world valuation data. The key consideration for utilizing trading comp valuation is to make sure you have the right universe of peer companies – which companies are the closest reflection to you in terms of size, product mix, growth potential, etc. Bankers will ideally look at a peer group of somewhere between 5-15 businesses, but in addition to simply looking at the group average, a smart banker will focus on the companies that look most like your business, and consider these companies’ multiples more heavily than the group’s average. Helping your banker understand the key differences between the peer group and your firm can help her understand which companies are most relevant and will have the biggest impact on the valuation of your business.

Transaction Comparables

Using transaction comps are hit-or-miss as a method for reliable valuation. The challenge with transaction comps is that there are likely a limited number (if any) of truly comparable transactions for a banker to consider. Assuming a banker is able to compile a list of transactions that make sense, the data surrounding the transaction (such as purchase price) is rarely publicly available. And when it is, a banker isn’t going to know what portion of the price paid was standalone valuation and what portion was attributable to other factors (synergies, control premiums, etc.). And finally, recency matters – market conditions, industries, etc. change. So, depending on what’s available, transaction comps can run the gamut from being virtually ignored in a valuation process to being a lynchpin in a negotiation of value. Often, as an industry insider, you’ll have information about recent company acquisitions that your banker isn’t aware of or doesn’t know much about. By filling her in with more details, she can build a more realistic model for your business.

Your banker has now run all the numbers, made the necessary adjustments, and hopefully determined a valuation range. If it sounds like conducting a valuation isn’t quite as formulaic as you might have thought, that’s because it’s not. No valuation method will ever truly account for all the unique attributes and idiosyncrasies of a business. The best a banker can do is account for as many variables as possible and settle on a range that makes the most sense. By staying involved in the process and providing information your banker may not have access to you can ensure you’re getting the most realistic valuation range.

And, though your banker is going to do their best analysis to predict an accurate valuation range for your company, remember that valuation is never perfect and that the only true way to find out the value of your business at any given point in time is to approach the market of potential buyers completely comprehensively with an excellent presentation of your business. That is the one final say on your company’s valuation — the price that the market of buyers is willing to pay.

 
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