Every business owner thinks that their business is worth at least a million pounds if not more and that is seldom the case. How do valuations work and what levers they can push or pull as a business owner to maximize the business’s value? The misconception is the inflation of the value of it like tesla is trading at 1,700 prices to earnings ratio in perspective. So, it means for every dollar that tesla adds to its bottom line investors are paying 1,700 dollars for that one dollar. How and when do tech companies or other companies have either pre-revenue or they haven’t made any profit give worth in future to the investor? People invest in these companies when the prices are inflated because people are overestimating their future’s worth. For Example. Tesla is a great company, it has a great product and is one of the few car companies going places but is it worth 1,700 prices to equity or price to earnings ratio. Tesla is an auto company it’s not a tech company. There’s a big difference between Tesla and Zoom. Scaling of zoom is easy relative to tesla because to scale software or to scale a tech company, there need a whole different set of infrastructure. Such as Tesla needs to buy more land, needs to build more plants, needs to hire more staff, needs to train them, pillars are made of cement and steel and cement takes so much time to cure. So, there’s nothing Elon Musk or Wall Street can do about that time. A tech company mainly don’t require these kinds of need. How much does valuation vary by industry? Valuation varies by industry very much and more than industry, valuation varies based on the business model. For Example, A company is not very big but they’re going places, right now they have 10 million dollars in revenue. Out of the 10 million dollars, 2 million is Sas revenue which is monthly recurring revenue, and 8 million in services revenue. The company is doing well and has 8 million that is based on services revenue. So, they can get a maximum of 2x on that 8 million which means 16 million, and 10x on the 2 million because it’s a monthly recurring revenue. So, 10x on 2 million which means 20 million. So, the company’s probably total worth is 36 million. Now, if they take that 8 million which is services revenue, and transfer that over to SAS revenue, somehow company change their business model and have to take a hit on revenue so instead of 8 million, the company make that revenue 5 million to convince their customers to make it a monthly recurring fee. So, instead of 8 million that becomes 5 and 5 plus 2 is seven, now 10x on 7 million is 70 million and the company just doubled the value. So, valuation is based on the business model. Buyers and companies are worth a lot of money only for two reasons:
- Buyers and investors want consistent cash flow. Sas cash flow or the monthly recurring revenue that is consistent.
- Buyers and investors don’t want to do anything to enjoy that consistent cash flow. They want to sit and enjoy that money. So, these two factors are where they can get consistent revenue and don’t have to do anything to enjoy that revenue and have a high valuation.
- Growth – How fast is the company growing or how fast the company can grow points that touched before the future value.
- Profit – How much money actually cash flow earnings or profit the company is making or in the case of venture capital how soon it can get to profitability.
- Risk – The business big or small does it have a lot of employees or few employees, does it have a lot of clients or customers or few customers. It’s the risk associated with the company.