Guest Post #1: Workbar Member Mike Moore Discusses Valuation
Working in both big and small companies, I’ve noticed that there is a LOT of confusion, stress and misunderstanding around estimating the value of a company. I’ll let you in on a little secret though, it’s simpler than you might think. There are three main questions your need to address:
- What value do you produce?
- What’s the “risk” of not delivering?
And MOST IMPORTANTLY
- Can you tell a compelling story?
As an entrepreneur, this SHOULD be the easiest thing to determine.
Ultimately it boils down to what do you sell/make/create that other people are willing to pay money* for. Being able to define what this value is should allow you to project out what your cash flow will be, per example:
- Jumpshell - The authority on how to find apartments in Boston
- Cater 2 me– Provides of the best hand-selected food delivered effortlessly to your office.
- DraftKings – Daily fantasy sports leagues for money
*But, wait Mike, what about companies that don’t make money now? (eg – Twitter, FourSquare, Google [just kidding on that one, wanted to make sure you are paying attention])…don’t worry I’ll get to those down below, but trust me, ALL companies are about making money in some fashion.
Risk – What are the chances that you (your company) doesn’t produce value?
Risk? What Risk?!?!
I’m sure as an entrepreneur you don’t see risk, you see opportunity and growth, which is awesome. That said, most of us have had seen a Hockey Stick Curve before, and know that there is virtually 0% chance that a projection will be perfect. What does that mean?
It just means there is uncertainty (risk) that whatever you are projecting, and you need to account for it. Luckily for you most industries or have industry standards or other companies you can use to get a sense of where to start.
Google, and a little creativity are probably your best resources, but here are some shortcuts on valuing risks:
Discount Rates– Basically, a discount rate is the amount of return an investor would expect to get in return for giving you money.
The higher the rate, the bigger the risk the company won’t be able to deliver on its projections.
Discount rates are most useful for companies with a track record of financial returns, because they are more stable and “easier” to predict.
Revenue Multiples – Revenue multiples are also a common way to estimate value. This approach is consists of taking the Revenue (or EBITDA if you want to get technical) of a company for a period of time (usually a year) and applying a number to that revenue figure (e.g. - $1 Million in Revenue at a 10x multiple, would be worth $10 Million).
Revenue multiples are useful for high growth/early stage companies. It is simpler to use an industry benchmark versus as opposed to trying to get a discount rate that accounts for all risk factors when they can be largely unknown
Comparables – To come extent you use Comparables, for your discount rate and multiples valuation approaches. In theory, these three should lead to a similar value (if it isn’t you just need to be able to justify why).
Cost – Using the cost method, just means that the company is worth exactly what you paid for the individual parts. This is generally used more for accounting purposes, otherwise that means you aren’t adding any value.
No Revenues, no problem - If you are valuing a company with no cash flows it’s more of an art than a science, but basically you need to find some proxy for how you provide value (e.g. – customers, market share, time on site, etc.) but for more detail Aswath Damodaran NYU Professor of Finance does a much better talking on the subject in this video. Which leads me into the last and most important part of valuation…
Storytelling – Can you tell a compelling story on why your company will grow?
Are you still feeling a bit uncomfortable about throwing together a valuation?
NO ONE KNOWS with 100% certainty what a company is worth and there have been countless examples mis-valuing companies for example:
The real key to valuations is being able to sell your value proposition to your audience by telling a compelling story, with the support of both numbers and words.
At the end of the day, your company is only worth what other people are willing to pay for it.
Hope that helps and if you still need help with valuation or financial modeling, just give me a shout.