The 2 Major Drivers of Company Valuation
Open up any corporate finance textbook, and you'll find pages devoted to valuation theory, valuation principles and mathematical techniques for arriving at a rational and dispassionate value for your company.
But no matter how sound these theories are, companies are valued in the real world, by real people with varied motives, amidst a dynamic market and uncertain future that no one can perfectly predict.
In order to achieve the best financial outcome for their business, entrepreneurs must focus on driving up their company's valuation by engaging constantly with investors and potential buyers and articulating a vision of their company's potential that is both expansive and credible. By the time an owner is ready to sell the business or raise capital, he or she must also seamlessly shift focus from the many and varied day-to-day operations of the business to the all-encompassing deal process.
Two key drivers will have the biggest impact on the valuation a company eventually achieves: reliable and defensible projections about future performance and the level of competition amongst interested investors and buyers.
While these may seem like elements beyond a business owner’s control, there are several ways to examine and prepare to meet these unknowns.
When an investor studies a company's historical track record, reviews your financials or interviews your customers, they're doing it to look for clues about the future prospects of the company. To paint this picture, CEOs should focus on the size of the company’s market opportunity, the speed and reliability with which they can serve their customer base and the defensibility of the product offering.
Particularly in an uncertain economic environment, the more predictable and sustainable a company's growth, the more investors are able to reflect that potential in the current price as they constantly assess the risk and reward of their investments.
Many entrepreneurs get mired in the details of valuation or put their head in the sand and simply pick a number based on their personal needs or what they heard was "right for their industry." Instead, they should try to see their business through the eyes of the investor or buyer in question, avoiding a textbook or emotional response, and focusing on crafting a compelling portrayal of the future potential of their company.
While a credible and compelling future makes it easier to demand fair value for the business, ensuring you're offered that price -- or higher -- means competition is a must-have. Without multiple uniquely interested parties at the table, there's little incentive for investors to come to that fair value (let alone maximize the offer).
It doesn't matter if a business has been growing at 100-percent top-line with impressive margins for 10 years straight -- in the absence of a competitive deal process, it's unlikely a business owner will achieve the best outcome.
Related: Five Smart Exit Strategies
For entrepreneurs more familiar with selling their product to customers than with raising capital or selling a company, it may be helpful to reflect on the sales process -- the richer the pipeline of customer prospects, the more choosey you can be about quality of prospects and the more disciplined you can be in negotiating the pricing and terms of the contract.
The same concept applies to raising money or selling your company.
Creating competition in a deal process is one of the primary functions and benefits of an investment banking professional. Similar to a great real estate agent, a great investment banker helps business owners drive to a fair outcome by ensuring there are multiple interested parties that are acutely and uniquely motivated to buy or finance the business.
As business owners prepare to raise money or sell their company, it's vital to ignore the noisy, free advice and focus on two things:
- Crisply and credibly articulating the future of the business in the most reliable and expansive way possible
- Devoting meaningful time to networking and relationship development (including meeting with investors before formally initiating a process and considering engaging an investment banker to run the process)
This two-pronged approach allows an entrepreneur to more readily take control of the deal process and thereby better ensure the most valuable outcome for the business.