When embarking on the valuation of a non-listed business, be it for the purpose of buying a stake in a business, selling an existing holding, buying out another shareholder or needing an indication of value for any other purpose, there are some basic guidelines that you should understand and follow. These basic concepts are applicable across any business operating in any industry, be it in manufacturing, agriculture, FMCG or a service based industry.
What is value?
According to the International Valuation Standard Council (IVSC) the definition of market value is: “The estimated amount for which a property should change hands on the date of the valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein both parties had each acted knowledgeably, prudently and without compulsion”.
In a broader context, value arises when a choice is made between alternatives. This choice is necessitated as the principle of scarcity applies to all resources, whether they be natural or economic. Whenever a choice is made amongst possible alternatives, one is foregone.
Such a concept is best illustrated with an example:
When investing in a business at a certain cost, the opportunity to invest in another business at the same cost is foregone assuming that the investee has limited investment resources. The potential benefit gained from investing in ‘another business’ may be defined as the “opportunity cost” of investing in the first business i.e. the benefit forgone of the best available alternative.
Alternatively, the seller would assess the opportunity cost of selling his/her share relative to not owning a share in the business in the future. The actual transaction price or exchange value would ultimately be dependent on the opportunity cost of both parties to the transaction, where there is a mutual interest, in particular circumstances, at a particular time.
The impact of different degrees of ownership on valuation
The value of an interest in a business is significantly influenced by the underlying weight of the shareholding being valued within the business.
The rights attached to a majority shareholding (51% or more) can include amongst others the right to sell or issue shares, the ability to determine salaries and bonuses and the decision to pay dividends. When acquiring a majority interest in a company, the investor often pays a control premium for these privileges.
Alternatively, a minority shareholder (less than 51%) is far more reactive, and can generally only voice concern and is more often than not reliant on decisions taken by Management such as the level of dividend payouts to be received. The impact of the lack of control should be taken into account during any valuation exercise, as the power to alter the course of the business and to direct resources will ultimately have an influence on the estimation of value.
In theory, the more influence a shareholder has on the business, the higher the value and visa versa assuming that shareholder has the best interests of the business at heart and is a competent decision maker.
Relying on the valuation of an expert
Where no open market exists for the shares of a business (e.g. being traded on a stock exchange) an expert’s valuation could form the basis of an indication of value at a given point in time.
One should remember that a valuation completed by any expert is merely the expert’s opinion of value at a specific point in time. In determining a reasonable valuation, the expert will apply various estimates, judgements and assumptions. This by no means implies that you are bound by the valuation, except if it has been agreed upon by the relevant parties that an independent expert will value the business and that that value will be taken as the value for future references.
One should always remember that a valuation is inherently dynamic and changeable and wherever alternative estimates, judgements and assumptions are applied it will have an influence on the estimation of value. Furthermore, a valuation is merely an indication of value and not by any means a price. A valuation only becomes a price when two willing parties agree to transact at the generated valuation. Negotiation sits between a valuation and a transaction price.
There are several theoretical valuation models available to value a business. Highlighted below are three models commonly used by valuation experts to determine an estimation of value of a business.
Earnings Multiple based valuation approaches
This methodology involves the application of an earnings multiple to the earnings of the business being valued to derive a value for the business. A multiple can be applied to an earnings base (commonly used P/E multiple); EBIT (Earnings before interest and Tax) or EBITA (EBIT before amortization) to estimate the value of a business.
When applying a Price /Earnings (P/E) multiple, the general practise is to first identify a Price/Earnings (P/E) ratio of a comparable listed company or the average P/E ratio of the sector in which the business operates (these P/E ratios are commonly reported). The rationale behind this is that listed businesses’ have a reported market value “at all times” which can be used as an indicator of the value of similar unlisted businesses.
This market-based approach assumes that listed businesses are correctly valued by the market and that comparable companies or the sector as a whole are in fact truly similar to the unlisted company being valued.
As it is extremely difficult to identify listed companies that are completely similar, the identified earnings multiple is often adjusted (with a discount or premium) for points of difference between the comparable company or sector and the business being valued.
These adjustments are intended to take into account the various influencing factors such as the relative risk of the business compared to the risk of the comparable business or sector, including the size and diversity of the business, the rate of growth, the diversity of product ranges, the level of borrowings and the risk arising from the lack of marketability of the shares.
The adjusted earnings multiple is then applied to a reasonable estimate of maintainable earnings of a business to derive at an estimation of value. A reasonable estimate of maintainable earnings is generally calculated by taking the historical earnings figures (or reliable forecast earnings figures) and adjusting it for exceptional or non-recurring items.
If, for example, an EBIT multiple is used, the same rationale will be followed, an applicable EBIT multiple will be identified, the EBIT of the business will be adjusted if needed (for non-recurring, non-operating items, etc) and a value will be calculated. The value as determined by the above calculation will in turn be adjusted for business specific circumstances and risks to get an estimation of value.
Discounted Cash Flow
This methodology involves deriving the value of a business by calculating the present value of the expected future cash flows of the company. In other words, the expected cash flows generated by the business are discounted at a fair rate of return to calculate an estimation of value at the current valuation date. The sum of these present values and a terminal value forms the basis of an estimate of value of the business. The terminal value is the projected value of the business at the end of the businesses lifespan.
The Discounted Cash Flow (“DCF”) technique consists of two distinct parts. Firstly, an estimation must be made of the amount and timing of all cash flows during the likely period or future lifespan of the business. The likely lifespan will differ from business to business and amongst different industries.
The basic information required to determine the projected cash flows would include, amongst other things, the estimates of earnings, depreciation and tax payable, net movements in working capital year-on-year, net realisable value of all surplus assets and estimations of the likely delay in selling them and the amount and timing of capital expenditure, all on an annual basis over the forecast period.
Secondly, a discount rate must be selected and applied to the cash flows to convert them into the present value. Generally the discount rate will be based either on the Weighted Average Cost of Capital of the business, adjusted for specific factors or it will be determined taking a holistic view on the required rate of return for the business (taking into account the systematic and unsystematic risk factors applicable to the business).
The estimation of the enterprise value will then be calculated by discounting the estimation of cash flows by the calculated discount rate. To get an estimation of value for a shareholding, total debt will be deducted from the calculation above.
Net Asset Value approach
This methodology indicates the value of a business by adjusting the business’s assets and liabilities to their market value equivalents. This model is most applicable for the valuation of businesses that derives its value from investments.
For all other businesses, it is advisable, under certain circumstances, to only apply this method if the business is on the verge of liquidation or split-up, or as a sense check of other valuation methodologies.
Judgements and assumptions
Throughout any valuation process, whatever the valuation model, the valuation expert will have to make his/her own estimations, judgements and assumptions based on information at his/her disposal. Because valuations entail many difficult estimates, scenarios, judgements and assumptions, there is scope for differences of opinion. A valuation can never be a precise figure, it is rather an indication of value which is often portrayed as a range of values.
As mentioned, if there is a difference of opinion, you are by no means bound to a transaction by a valuation expert’s estimate of value, except if it has been agreed upon beforehand by the relevant parties.
Understanding the valuation model, estimates, assumptions and their implications
When using the services of a valuation expert, on presentation of the valuation report by the expert, you as the client should interrogate the expert with reference to the choice of model applied. Further to this, the expert should explain all possible deviations from the chosen model and explain its implementation in detail so that you the client/business owner have the same understanding of the underlying model as the valuation expert.
Furthermore, you the client should also question the valuation expert on the estimations and assumptions that he/she has made and the associated influence of these assumptions on his/her valuation, so that you are able to fully understand the impact of changing macro and microeconomic circumstances. This will allow you to see how the valuation will change when differences in opinion are applied to the model or where market circumstances change significantly.
All applicable information needs to be taken into account during the valuation process, from an industry analysis, to financial information (financial statements and management accounts), risk analysis to all relevant legal documents. The quality of information going into the valuation process will influence which model will be used, the estimates, assumptions and ultimately the quality of the estimation of value. Care should be taken that all applicable and necessary information should be taken into account when calculating an estimation of value.
The same holds true should the valuation be performed by an expert – the quality of information given to the expert will determine the quality of the estimation of value. Garbage in equals garbage out.
The calculation of the estimation of value of an interest in a business is a process where various building blocks are used, information analysed, with different models available for application. The answer is always an indication of value and at best an informed estimation of value.
Ultimately, it is always still up to the potential buyer or seller to negotiate the final price and terms and conditions of a potential transfer of interest.
- Valuation of Unquoted Companies, Fifth Edition (2009), Christopher Glover. Wolters Kluwer (UK) Ltd.
- Financial Management, 6th Edition (2007), Correia et al. Juta & Co. (SA)
- International Private Equity and Venture Capital Valuation Guidelines (September 2009). IPEV Board. www.privateequityvaluation.com
Where Should You Begin?
It goes without saying that the right people on your team make all this possible. But this is a topic for another day.
When I first started what was to become IndieFin, I really didn’t know where to begin. I had been granted a tiny bit of funding – enough to last about a year – on the basis that I could figure out how to reinvent financial services for the digital generation.
The initial challenges were plentiful. My experience with technology was exclusively as a user. So, I had close to zero knowledge on how to execute anything that I dreamed up. I also was very aware that the financial services industry had a reputation for offering awful customer experiences, so the bar there was very low. And finally, having spent a good few years working on developing financial products in the industry, I realised the opportunities to improve on the industry’s products were vast.
While this sounds like a fairly ideal situation for an entrepreneur, and while I feel very grateful for the opportunity, the real challenge was that there were simply so many things that could be built, all of which would present radical improvements on the status quo.
A couple of us sat in a room and started putting ideas down on a white board. We went wild, and kept coming up with more and more great ideas. In fact, we came up with both a very compelling retail investment proposition, as well as what turned out to be our insurance proposition.
What this exercise revealed, was that ideas alone are pretty useless. And, too many ideas can paralyse you.
Our small team got stuck in that trap, which was made worse because we didn’t (yet) have the skills to bring any of those ideas to life.
We wasted a good few months (and some money) simply working on the details of multiple ideas. We were generating lots of documentation, and a few pretty pictures, and truly believed we were making progress.
In reality, we were running on the spot. Things changed with the addition of some new talent – who brought with them a completely different approach and complementary skillsets. This combination of people changed how we were doing things, for the better, and we managed to launch something into the market a few months later.
If I could take out the key lessons from this early stage of our business, they are:
- Choose one thing to do, and focus all your energy on doing it. This does not mean you throw out the other good ideas… but put them on the “not yet” pile.
- If it’s going to take you longer than three months to build and deliver your one thing to the market, it’s still too big. Strip it down to its core, until you can confidently build it and ship it within a quarter. This may feel like you are watering down your idea, and maybe you are. However, working to a longer timeline than this will stall you, with the risk of never getting anything shipped.
- Launch what’s ready. You will know what can still be done to make it better. It’s scary to launch something that is nowhere near your mental picture of what it can and will be. Do it anyway.
- Be ready to learn. The best market research you can conduct is with real people using something you’ve built in the real world. Sure, you run the risk of brutal feedback (and perhaps it’s because it was launched early), but the free lessons you learn will be priceless in developing version 1.2 and 1.3 and 1.4.
Fear is your enemy at this stage of the business. Personally, I needed others to challenge that natural fear, and push “go”. And I’m glad I did. Most of what we built in the early versions of the product releases were not even on our original roadmap. The stuff we have built since launching, and which we are still going to build, have been inspired by our customers and the lessons we have learnt in launching something incomplete.
It goes without saying that the right people on your team make all this possible. But this is a topic for another day.
4 Things Your Start-Up Needs When It Opens An Office
There are certain things you should definitely ensure your office has. If not before you move in, then as soon as you can set it up.
So, your start-up is finally up and running. You’ve been dreaming about this moment for as long as you can remember. And now you have clients or customers, a small team of dedicated employees and you’re turning a decent profit. Which means it’s time to move out of your garage and into a proper office.
You don’t want your staff filling up your personal space at home. Your garage, although creatively decorated, simply is no longer big enough. Plus, there simply isn’t enough parking on your street. It’s time you go from a bunch of youngsters with a big idea to a proper business with a premises you’re not afraid to invite clients to.
But, first, you need to choose this office and it’s that’s not a task you should take lightly. Obviously, you want to keep that creative startup vibe you’ve worked so hard to build up, so a space in a corporate office block isn’t going to work for you. You need to choose something that conveys your independent nature and inspiration-led work ethic.
However, there are certain things you should definitely ensure your office has. If not before you move in, then as soon as you can set it up.
At least one boardroom
You and your employees may be all about a “shared space” where everyone knows what everyone else is up to. But, unfortunately, it’s time to face the fact that you’re going to need at least one boardroom in your new office. Why? Because you will now be hosting clients and investors and they will want to discuss their wants, needs and expectations in a quiet place where they can hear themselves think.
Of course, this boardroom doesn’t have to look like it belongs in a big corporate office. You can decorate however you want. If you want to give the appearance of transparency with your staff, so they don’t freak out every time you drag all your senior employees into the room, you can always have glass walls that are easy to see through.
You’ll also want to incorporate some impressive tech into your boardroom to wow your clients and investors. Interactive whiteboards and touchscreen tablets at each seating place will give the appearance that you have, literally, got technology at your fingertips.
Security you can trust
And with all the tech that comes with owning a startup, you’ll want security to protect all your assets. This is not an area where you can afford to skimp on costs and save money.
If you’re in an office park of sorts (the kind that still allows you to keep your creative vibe), there’s probably already a security guard doing the rounds regularly. However, it’s up to you to ensure you can monitor who enters and exits your premises.
A great way to do this is with a fingerprint scanner at your front door or a tag system. Just make sure you take ex-employees off the system as soon as they leave and are able to add new employees just as quickly.
Now you need to focus on internal monitoring. A video wall controller paired with strategically placed cameras around the office is always a good idea. That way if there’s ever an incident, it can be caught in real time and even recorded for later use as evidence.
You’re investing a lot of money in your business assets as well as your space, so it’s important you’re able to protect everything and everyone.
A kitchen with all the necessary appliances
Yes, you’re going to need somewhere for your employees to make that coffee they need in order to work like the rockstar machines they are. But you’re also going to need a place for them to store their lunch, heat up food and even make food if necessary.
This is especially important if there’s nowhere near your office for them to purchase food. And if you want people to socialise while they eat, make sure your kitchen is big enough for a giant table where everyone can eat together. If that’s not possible, try setting aside space inside the office or even outside the office.
Space for people to move around
As a start-up made up of young people with bright ideas and a collaborative working style, you will likely want to have an open plan office. And that’s great. However, you have to ensure there’s enough space for everyone to move around.
Your team will eventually grow, so you can’t simply create space for the staff you have. You don’t people feeling cramped and uncomfortable.
It’s time for your start-up to move out of your garage and into your own office space. But that doesn’t mean you have to let go of that creative environment you’ve worked so hard to cultivate.
How To Build The Right Mindset For Start-up Success
When clarity, consistency and execution become your signal characteristics, getting what you want becomes automatic.
Mindset matters. Whether you’re a founder, CEO, first-day-on-the-job newbie, or bold, would-be entrepreneur, if your mind isn’t right then your decisions aren’t right. And with suboptimal decision making comes suboptimal results. How you show up everyday determines how you tackle the challenges that come your way.
However, oftentimes what gets in the way is ourselves – our thoughts and emotions. If you dislike public speaking, for example, what might go through your mind if asked to present in front of an audience is that little voice in your head saying something like, “I hate speaking. I’m not good at it!” Your heart skips a couple beats, your hands become uncomfortably moist so you pat them on your pants which doesn’t exactly help your self image and then you begin stammering. Congratulations, you’ve just entered the realm of weird.
Don’t let emotion get the better of you. Stay focused on what matters by learning to separate emotion from reason so you can focus on what you need and not be swayed by what you want.
Related: Smart Money For Small Businesses
Having the right mindset begins with identifying what you want. Without a clear picture of what winning looks like you’ll never know if you’re on the right path, which means you can’t course correct. Take the time to clarify what “success” looks like to you.
You might want to become more disciplined, improve your focus, or learn to talk to yourself more effectively (yes, self talk is a skill). Clarity creates two things. It creates meaning, and it creates guidance for you to focus on which allows you to better communicate not only with yourself but with your team as well.
It’s easy to take leadership, teamwork or any of those “soft skills” for granted, but without them a company wouldn’t exist. Get clear on what good leadership looks like; what effective teamwork looks like.
When you know what right looks like, you can make immediate adjustments to get back on track even after they’ve gone wrong.
Make consistency a habit
Being great at anything requires two things: Consistency and effort. You have to do the work to be great, and you have to do it consistently. Muscle doesn’t build itself (trust me, I’ve tried). You don’t get stronger by doing some pushups whenever you feel like it. You improve by going to the gym consistently and doing the work to get stronger.
Leading a team or a company requires the same consistency of effort. You get better at communicating by communicating. You get better at focusing by focusing. You get better at working together by working together to get better – and doing so consistently.
Now, while consistency and effort are two critical ingredients to crushing anything in life, so too is learning. After all, you can be as consistent and as diligent as you want, but if you A) don’t have a clear definition of success, discussed above, or B) don’t learn from past mistakes, then you’re only getting to the wrong place faster. Make learning a habit by consistently learning, and you’ll develop the mindset of constant improvement.
Suspend judgment to get stuff done
I remember in first phase of BUD/S (Basic Underwater Demolition/SEAL training) an instructor giving us an example of the type of mindset that every SEAL has – the type of mindset that gets stuff done. He told us that if he had to go run 25 miles right then and there because it was critical to mission success, he would. He would’ve done it not because he liked running or because he was ordered to, but because it was something that just had to be done.
The takeaway is that you don’t have to like everything you do. You just have to do it (whatever it happens to be). To really make an impact in your work or in life in general, suspend judgment. When you suspend judgment you forego any emotion attached to that judgment. Then, all you have left is action versus inaction, do or do not do. It’s not easy, but then again nothing good ever is. Do it anyway.
Being right in anything requires clarity, consistency and effort. There’ll be bumps in the road, no doubt, but those bumps are what make you better.
This article was originally posted here on Entrepreneur.com.
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