If you manage or own a mid-sized company, Do you have explicit knowledge of its worth? Now, in this time? Are you aware of what value you added over the last year? Do you know where your business’s value is generated and the areas where it’s decreasing?
The answer to one or all of the questions above to any of these questions is “no,” and you could put yourself and your business in danger.
Recently we (Reed) advised an established family business with three distinct companies, all of which were in specific industries.
Two firms had been performing well in promising fields, and the third was struggling in a depressed industry, in which valuations had fallen to a record low and were unlikely to recover.
In the end, management focused on repairing the struggling company rather than committing most of their time and effort to the business performing more efficiently.
The adverse effects of this method were evident only after the business was eventually sold. Since all three firms were located in different sectors and had various industries, the sale involved three buyers. The companies that performed well earned about 75 million each.
The struggling business that received all their focus — earned only $12.5 million.
Imagine the potential value of the company’s combined value if the management concentrated their efforts on the areas worth improving by investing in innovative talent and innovation, expanding the customer base, improving quality, and so on. In the next few years, a well-planned growth strategy could have boosted the already profitable businesses until buyers would have been ready to fork out a premium of 25 of $100 million instead of the $75 million.
Even if these investments had needed to shut the third business down, the total 50 million increase in market value would have been more than enough to compensate for the expenses of closing a lousy company.
Although any business can make mistakes, family-owned businesses are more at risk. Their rich traditions and histories (often one of their greatest assets) could become liabilities if emotional attachments lead managers to stay in the loop for too long or refuse to embrace the new direction. For these companies, transparent, objective valuations provide necessary reality checks.
Unfortunately, many managers and owners of midsized privately owned firms (family-owned and not) work throughout the day with no idea of their worth. This is because busy executives think there’s no straightforward method to calculate the value, leaving the issue off. Contrary to their public-traded counterparts, they do not have the advantage of automated daily valuations that are that is based on the price of their stock and also don’t have teams of corporate strategy directors waiting to evaluate the creation of value. Many managers of midsize businesses consider third-party valuations difficult, time-consuming, costly, and intrusive. They, therefore, undergo these only when they have to, such as, for instance, or when they seek capital to fund expansion.
Even with these issues, even if you run or manage a mid-sized company, it is imperative to do a thorough appraisal yearly. Consider it like the annual physical. It’s an essential step to figure out the root of what’s not working and, more crucially, what might be wrong. You can then make corrective steps ahead of time.
You can avoid wasting time and money in pursuing customers who aren’t the right ones, trying to increase the size of your declining business, or not being able to identify and invest in the areas that offer the most significant potential.
In addition, if you’re approached by buyers interested in buying your business, you’re prepared to negotiate and respond. Instead of searching for some vague “X numbers EBITDA” figure you heard at your last industry gathering, You’ll have a clear understanding of your company and not only those similar to your worth and what it’s worth.
A More Accessible Valuation Method
To make the valuation process more simple and accessible, we developed an entirely new method called QuickValue. It’s based on Reed’s years of experience working with hundreds of middle-market executives and helping them know their businesses’ worth and why.
To conduct this self-guided valuation, your company’s internal team isn’t required to have any financial projections for the future. Most of the information you need is available, and the information that isn’t available can be readily obtained. Your company’s executives know what they are doing better than anyone ever could and will not need to introduce anyone on the learning curve.
Our method for this exercise involves carefully examining your business’s top value drivers and the characteristics of your company that make it distinctive. Even companies in the same industry with similar metrics can differ significantly in everything from the level of their leadership and the power of their pricing to their brand equity. So, a meticulous thorough, and accurate evaluation of the value-driven factors are crucial to determine a business’s worth.
In the beginning, you’ll determine the most significant factors that drive your business’s value. We suggest selecting between eight and 12 and then evaluating each one on a scale of zero from 0 to 10, a score of 10 being the most desirable to calculate Your Value Drive Score. The score is an essential part of the valuation process, as it measures the qualitative aspects of your business that many valuation techniques do not consider.
You and your team will use market-rate multiples for publicly traded companies to determine the value of firms that are similar to yours. If you’re a privately-owned midsize business, you’ll have to account for the smaller multiples (typically 25-30 percent less) associated with M&A transactions involving private companies.
The next stage is bringing the pieces to make it all. The process of obtaining the three essential elements of information — your evaluation of your value drivers as well as your EBITDA multiple along with your adjusted EBITDA is a bit of time and effort; once you’ve done that, a straightforward calculation can yield the figure you’re looking for: a precise and well-substantiated worth for your business.
- This process of valuation can allow you to:
- Please do not sell your business for a profit concerning its actual worth.
- Focus on ways to enhance your business by increasing the value factors.
- Develop a strategy with value creation at the center.
- Incentivize your employees according to the value they bring to the company instead of using revenue or EBITDA goals.
How to Know What You’re Worth
Take a look at the following hypothetical scenario. A rival confronts company X with an offer to buy. As the competitor claims, the cost will be based on the most widely-used industry multiplier of 12x EBITDA. Both companies are in an increasing industry and are doing quite well.
Fortunately, the managers of Company X have recently conducted a self-assessment on the value of their company. They believe they argue convincing and defensible to value their business at 18x EBITDA and not 12.
How did they achieve this? A team of internal senior executives who covered the core disciplines of marketing, finance, product as well as manufacturing collaborated to discuss the most valuable drivers that were significant. Dispensing with drivers that didn’t apply to their software business, such as supply chain and franchiser-franchisee relationships, the team determined that areas such as intellectual property, leadership, and pricing power mattered most to their development and success.
They then rated themselves for each driver on a scale of zero to 10, with more weight given to drivers they believed to be the most significant. It was a lively candid, open and honest conversation. They made sure to evaluate themselves with thoroughness and included both drivers who excelled and the inevitable ones that had to improve. They added these scores to get 112 of 140 possible points. Although the team scored just ten value drivers, one was considered crucial and was given a triple weighting (30 points). Two were rated as extremely important and awarded two weightings (20 points), while the seven remaining received a standard rating of 10 points. We were utilizing our method, and they received a score of 80 percent (112 points multiplied by 140) — which is an impressive score that is only given to the most successful firms.
Then, they looked into the EBITDA multiples of fifteen public companies within Company X’s sector. (In this instance, the investment banker they were familiar with offered this information, although there are numerous methods to get it fast.) This enabled them to create an estimate of value, which was then adjusted slightly downward to consider the difference between private and public corporate M&A multiples. It was between 10x, and 20x EBITDA is the range in which Company X would find its worth once it had applied its score. The company’s high score places it in the upper tier in the EBITDA range, with 18x, which you can read in this table.
When Company X had been acquired at the cost its rival offered, the price would have been an attractive deal on behalf of the prospective buyer. This is because companies selling at 12x EBITDA are much less profitable.
By refusing this offer, Company X dodged a bullet. The company’s $11 million EBITDA means the company is worth around $180 million (18x EBITDA), which is more than the amount given.
It’s important to remember that the scenario above provides a top-of-the-line system. Many companies do not deserve an enviable score, so we employed the term “defensible” to highlight an explanation. Any prospective buyer quickly discovers self-assessments that exaggerate with due diligence. In addition, self-deception is not in line with the concept of this exercise because you’ll never get any information you can build upon. When an objective appraisal provides an unsatisfactory value for your company, it isn’t enjoyable. But it’s an invaluable piece of information you can apply to build your company’s strength.