Before proceeding with a sale it makes sense to estimate the present, fair market value of your business. Knowing the value of your business is important because when you receive your first offers, you want to compare this against market valuations, to check whether you received a fair offer.
There are several ways to estimate the value of your business, with different methodologies ranging in complexity, from a relatively straightforward 'back-of-the-envelope' calculation to more detailed financial modelling.
The most commonly used valuation techniques are:
- Comparables (transaction and public comparables)
- Discounted Cash Flow
- Leverage Buyout Model
A quick overview of comparables
Of the three methodologies, comparables are the most straightforward method. It relies on collecting a series of data points (multiples) and applying these to the financial metrics of your own business.
These multiples represent the ratio between a comparable company's enterprise value and its financial metrics, such as revenue or EBITDA. After these ratios have been calculated for several comparable companies, all the data points are averaged to find an average revenue or EBITDA multiplier.
The relevant multipliers are then multiplied by the metrics of your own company, to derive the enterprise value of your company.
For instance, imagine that you are selling a footwear e-commerce store, with a forecast FY23E turnover of £2m. Suppose you had received an offer valuing your company at £10m, how could you estimate whether this is a fair offer?
Suppose that, having looked at the EV / Revenue multiple of five comparables, the EV / Revenue multiples were respectively 5.50x, 4.50x, 5.00x, 4.00x, 6.00x. The average EV / Revenue multiple would be 5.00x.
Applying this to your FY23E turnover figure of £2m, would suggest that the £10m offer was at a fair valuation.
A Discounted Cash Flow (DCF) summary
A DCF implies that a business is as valuable as the sum of all its future cash flows in perpetuity, discounted to present value. It is not always relevant, especially for less mature companies, because it implies that your company is cash flow positive. This means that
There are three parts to a cash flow.
The first part consists in forecasting all cash flows - this can be done up to five or ten years into the future and represent the free cash flows to the business' debt and equity holders.
The second step involves calculating the Terminal Value of the business. This means estimating the value of the sum of all cash flows (beyond the ones already calculated) remaining in perpetuity.
The third step consists in discounting all calculated cash flows to present value, using a calculated discount rate specific to your sector and business, and then summing them together to calculate the Enterprise Value of your company.
How a Leveraged Buyout (LBO) works
LBOs are mostly used by financial investors (such as private equity funds) to structure the acquisition of the company. The main principle consists in acquiring the target and applying a considerable amount of debt into the capital structure.
On average, the tenure period of a target company can range between three to seven years. During this period, the fund would focus on growing the company through a combination of organic growth and, oftentimes, smaller bolt-on acquisitions. In addition, the debt is paid down from the company's proceeds.
When the company is sold, the value for investors originates from the growth in the company, implying a higher value from its sale than when it was acquired. But it also comes from a partial amount of debt outstanding, given that a portion of debt would have been paid during the holding period from the company's proceeds.
When preparing an LBO analysis, an investor will value the company as of today based on the desired returns at exit in a few years. Therefore, by forecasting the future value of the business at exit and the remaining amount of debt outstanding, an investor can estimate what an appropriate purchase price for the business might be as of today.
The potential economic benefit from having an expert advise you on valuation will almost certainly outweigh the costs. An Ithaca expert can help you estimate the value of your business today to help you understand whether you are ready to sell your business or can provide counterparties guidance on valuation when they are about to put through or revise their offers.