Prove Your Worth

Value 101

The price the company might sell for on the open market is the basic value benchmark. This can be determined by examining recent sales of comparable businesses. But no two businesses are the same, and selling prices vary according to what the buyer is looking for. Ratner had his business formally valued in anticipation of an expected bid by a large pet supplies retailer to buy it. The value came in at what he expected and at what the bigger firm typically paid for acquisitions-about five times annual earnings. The prospective buyer didn't offer a bid on the company after all, because Ratner's low-cost, out-of-the-way areas didn't match the bigger company's practice of locating in high-cost, high-traffic spots.

Expected future cash flow is the most common basic benchmark for setting value. So, typically, you build value by increasing the amount of profit your business can be expected to generate in the future. That's how Robert LoCascio saved LivePerson Inc. from losing its listing on NASDAQ. LoCascio, 34, founded the live-chat customer service company and took it public in 2000. Despite never earning profits, shares in the company traded as high as $8 before the Internet bubble burst. Then they fell as low as 7 cents, and delisting loomed.

LoCascio made LivePerson profitable by acquiring an Israeli competitor that owned technology, which drastically cut his costs. "Our original cost of goods was about $600,000 a month," LoCascio says. "When we acquired the company from Israel, their cost of goods was $60,000 a month." A year later, shares in the 100-person New York City company were trading at 30 cents each, and early this year, they topped $1-a 14-fold increase in value despite poor market conditions.

You can also boost value by increasing sales or some derivative of revenues. Rory J. Cutaia's benchmark for valuing The Telx Group Inc. is revenues per square foot. The 34-person telecommunications company sells space in its New York City facility to large telecommunications companies and users who want to be able to connect easily and quickly to each other.

When the telecom market crashed, Cutaia, 47, was still able to increase revenues per square foot by finding ways to encourage his customers to do more business with each other. The techniques were as simple as hosting get-togethers for customers to meet each other and pitch their services, but it's worked well over the last two years. "Revenues have tripled, EBITDA quadrupled, and the company is much healthier," Cutaia says.

Unfortunately, healthier companies aren't always worth more. Because he's so deeply tied to the telecom industry, which has been in a steep and long-lasting decline, Cutaia figures his company may be worth less than it was two years ago. At the very least, he's not getting a good rate of return on the sales improvements he's making. "Our revenues have more than tripled over the past two years," he says, "yet our valuation has probably declined."

Cutaia is not the first entrepreneur to work to boost value only to see it stay the same or even decline. Ratner tried opening a new location he thought would appeal to another acquirer, but the new store didn't fit his operation, and he eventually had to close it.

Building value, notes Manganelli, is often counterintuitive. You may have to go against industry wisdom or sell off assets you would rather keep. Often, entrepreneurs find it's essential that they de-emphasize their own role in the business if they want to be seen as more valuable. Other times, they may need to terminate longtime employees and bring in replacements.

These days, it's important to be able to stand up to intense scrutiny when you do anything to increase value or place any value on your company. "Forensics and fraud [are] the hottest segments driving valuations," Dinas says. Part of the reason is the spate of high-profile blowups like Enron, where billions of dollars of value disappeared as a result of questionable or fraudulent accounting. Another cause is the introduction of new accounting rules that require re-examination of valuations used in mergers and acquisitions.

What's It to You?
Think you don't need to build the value of your company because you don't plan to sell? There are dozens of reasons for entrepreneurs to be concerned about the value of their companies. Following are some of the most commonly encountered:
  • Adequacy of life insurance
  • Allocation of acquisition price
  • Bankruptcy and foreclosure
  • Buy-and-sell agreements
  • Calculating controlling interest
  • Charitable contributions
  • Divorce
  • Employee stock ownership plan
  • Estate and gift taxes
  • Fairness opinions (opinions as to whether the consideration in a business transaction is fair from a financial point of view)
  • Family limited partnership
  • Financing
  • Franchises
  • Gifting
  • Incentive stock options
  • IPOs
  • Lease vs. buy decisions
  • Leveraged buyouts
  • Liquidation support
  • Litigation support
  • Mediation and arbitration
  • Mergers
  • Partner disputes
  • Purchase of a business
  • Sale of a business
  • Split-ups and spinoffs
  • Succession planning

Source: National Association of Certified Valuation Analysts

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This article was originally published in the July 2003 print edition of Entrepreneur with the headline: Prove Your Worth.

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