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.
Basically, companies should focus on the business model, the more you can make your business model into a subscription-based instead of a revenue share, it would be better for valuations.
Is there a general rule for valuing businesses?Rules of Thumb – Business Worth
No, rules of thumb are important. Not everybody needs valuation, not everybody needs to hire schmucks to get the evaluation. People need to be careful about using a rule of thumb. It’s not applicable to everything or to all businesses. Use a rule of thumb that’s applicable to your business.
How do companies know about what is their business worth without giving any actual details to work?
If your business is giving you a certain cash flow like 10,000 pounds a month then how much business mortgage can that business support and whatever that might be is approximately the value of your business. So, as a rule of thumb, it can be anywhere from 3 to 5x on earnings.
How can have a large valuation for businesses which haven’t actually got a profit yet?
Profit is important but, when talking to venture capital folks, profit is not that important. In valuations, generally, there are three factors that are most important.
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.
So, if assessing any business or any investment from the lens of these three parameters you will not go wrong.
What are the reasons to value a business excluding the sale of it?
There’s a need for why one might ask for evaluation and usually those needs they’re hoping and expecting or anticipating some kind of a transaction, selling a part of the company or shares of the company or the entire company. They might need an evaluation for different purposes such as insurance purposes, tax purposes, accounting purposes, lawsuit purposes.
How frequently does a business value match the selling price?
Selling or buying a business is very different from buying or selling a house because selling or buying a business is not static. Business is a moving object, living, and breathing and a house are fairly static. If a house doesn’t use for a month or two weeks or two months, it’s not like it’s going to destroy itself, whereas a business needs to take care of it for a month or two. If a business doesn’t care then it can just implode. So, a business is a moving target. Selling a business is different from selling a house. When you sell your house you just walk away from it. When you’re selling a business you are taking on a long-term partner and can’t just walk away after selling a business just like after selling a house.
Can a customer list value?
Yes, there’s value to everything. So there’s a value to a customer list, value to a patent, value to a trademark, value to trade secrets. It depends on what you’re buying. Sometimes, you don’t like the business because the business is not profitable but has awesome customers. So you will buy the business because of customer relationships.
How many years should a business be trading to get an accurate valuation?
It should be at least three or five years to show some kind of history but it’s not a rule of thumb. Because if somebody’s looking to buy a business that’s been around only for six months that would be like what existing or what pre-existing demand are they getting for that business which has become so valuable that somebody wants to buy it within six months.
How accurate are shark tank valuations?
Shark tank is a good show. The investors are always looking at a few things:
They’re looking at the entrepreneur. They are looking for two things that can this guy/gal deliver whatever he/she is promising or can they do, what they say. They’re trying to assess that in within minutes they’ve got. They’re trying to understand that whatever product or service the business or founder is providing is there a demand for it? It’s far easier to build a product or service or a company based on something where there’s a pre-existing demand. Does the company have any kind of revenue? If there’s a demand do they have a product? They’re trying to understand how much an entrepreneur looking to raise a hundred thousand or a million dollars or two million dollars. How is that raised compared to the revenue that they currently have? So, if their revenue currently is zero and they’re asking for two million bucks then it’s a red flag. If their revenue is 2,00,000 and they’re asking for 4,00,000 then it would be ok. So, 4,00,000 can probably cover the 4,00,000 within a year or two.
What are some of the most common mistakes owners make before wanting to value their business?
Most owners build products or services first and then they try to find a demand for something that they just created. So, they’re putting the cart before the horse, and first, understand the all pre-existing demand of the customer. Most times, entrepreneurs are trying to find a demand for a solution. If there’s a pre-existing demand for something then your business is going to shoot through the roof and that’s a high valuation, whereas if the demand doesn’t exist and then you’re creating the demand then it’s going to be a very slow process.
For Example, The taxi cabs demands already existed and Uber’s just switched the business model. They didn’t create a taxicab demand from scratch.
A company has a different perspective and valuation depends on the perspective. For Example, for one investor, Uber’s worth is 100 billion and for another investor Uber’s worth is 80 billion, or for another investor, Uber’s worth is two billion but they all are not wrong as value depends on the perspective. Valuation is a subjective opinion of value based on objective data. So, it is a combination of subjectivity but it stands on the foundation of objectivity.
Most people have no idea what the business is worth. Sixty of small businesses are owned by people, who are baby boomers and baby boomers are between 55 and 75 years of age. They all want to retire in the next five to 10 years and as a business owner if they want to retire then they have two or three options. 1. Sell the business or could give it to the next generation 2. Could shut it down ideally. Most of the owners don’t have an idea of what it’s worth or how to increase its value.
Read more about it on the What’s it Worth Youtube channel.
