Why it matters to know what my business is worth
From the largest corporations to small family businesses, every company needs to know what it's worth. This information matters because it tells us what we can ask in exchange for a stake in our company and whether the offer on the table is good or bad for us as investors or businesses.
After all, to get a good deal, it's key to know the real, intrinsic value of what we're buying or offering, and relate it to the price paid.
Valuing a business is not like putting a price or estimating the monetary worth of any product in a regulated market. To give an accurate, well-founded valuation of a company, you need to combine a multitude of factors: weigh their relative importance in the company's overall value, understand the market it operates in, the potential of the company's mission, the quality of its human capital, and so on.
Challenges in determining what my business is worth
When large companies face an acquisition, a merger, or a capital increase (or any other major transaction), they rely on lawyers, accountants, auditors, consultants, and all kinds of professionals from specialized firms to obtain the best possible valuation, and then negotiate and act on that information.
Small and medium-sized enterprises operate in a much more fragmented environment. One of the Achilles' heels of the M&A sector for this type of business is the lack of transparency
SMEs approach this task, and these negotiations and deals, facing a much more difficult landscape, even though the importance of carrying out a proper valuation is equal or even greater, since inorganic growth can be a differentiating strategy with an enormous impact: a true game-changer.
What I need to value my business
With all this in mind, and to shed some light on the subject, here are the main keys to valuing a company:
1. Financial data and projections (and the rationale behind them):
It's essential to review in depth the financial information contained in the annual accounts, as well as any information not reflected in them, whenever it's available. These are the key figures you always need to study to get an accurate picture of a company's value:
- EBITDA (the company's gross operating earnings)
- Revenue or net sales
- Free cash flow (FCF)
- Various ratios such as solvency, leverage, annual growth, and so-called working capital – the relationship between current assets and short-term liabilities, among others.
It's also essential to dissect the balance sheet to see which resources, fixed and current, tangible and intangible, the company has to generate business and sales. This shows us how it finances their acquisition and upkeep, and reveals the obligations it has to shareholders and third parties, their maturities, and its capital structure.
Finally, it's key to have a forecast of where the company is heading: what it expects those financial figures to look like, what changes and improvements it intends to implement, and the basis for justifying them, in order to see how realistic and feasible those financial projections are.
2. Human capital
Knowing who is behind the projects and the companies, what experience they have, and what they can contribute that sets the company apart from its competitors and makes it a success is essential.
This factor, which carries a significant subjective element when it comes to putting a figure on that value, can be, and often is, the one that makes the difference, so it's becoming increasingly important when valuing a company.
3. Comparative advantages and differentiating factors
To know a company's value, you need a solid understanding of the market in which it operates, in order to grasp its potential, its needs, and the comparative advantages and differentiating factors that set it apart from its competitors.
These unique qualities can have:
- A clear, measurable impact, such as a license, a store's location, or a high-value contract
- A more relative, intangible value, such as the know-how and prestige associated with a traditional, century-old company. For example, Apple's unique design or Inditex's fast fashion model
Either way, these qualities are fundamental to generating sales and growing the company and, consequently, to establishing its value.
4. Product and market
Finally, we also need to include in our equation, and weigh appropriately, the product, the market, and, consequently, the company's results. That's why you should analyze:
- The product or service, or product line, that the company offers, which should be analyzed in light of a specific time and place, to see whether what it offers still has room to grow or is in decline.
- The market or markets in which it offers its products or services. You should analyze whether they are expanding, or even thriving or booming, whether they are in a stable or stagnant phase, or whether they increasingly have less purchasing power, fewer customers, and, in general, fewer opportunities.
Combining all of these factors gives us a clearer view of the company's value, which can be very different from the price at which it's sold or at which shares or equity stakes are offered.
Done properly, this can help us negotiate better, get a better deal, and take advantage of all the possibilities inorganic growth offers, as long as we correctly answer the million-dollar question: What is my business worth?
