How can a business owner “rough out” approximate value of his company for purposes of keeping tabs on how he’s doing?
The purpose of this article is to give owners just a “feel” for what high or low performance and circumstances might really do to free economic value of the business you might own today. Of course, there is no guaranteed formula that always gives a right answer, but we hope that the analysis which follows may give you some reasonable concept of the likely big boosts (or big potential cuts) to value in your company, and offer some ideas for target parameters likely to hike your company’s potential for one-day salable value!
The single most simple, and usually most accurate way to begin with estimation of value is, for a mid-sized company which is operating at a profit, to begin with a multiple of earnings. For purposes of this discussion let’s say “mid-sized” probably means a company which is usually at least several million in sales, and it would normally have to be a profitable company, to have value above pure asset liquidation levels.
The first step in development of such a valuation is to realistically look at what the company would be producing, in pretax earnings, if all of the owner benefits and costs were removed. Usually that means you begin by adding back all owner take-out that is hitting company expense, but then deducting a fair amount for the replacement cost of outsiders who might be hired to perform the same roles. For companies where the owners take out a great deal in salaries and benefits, the net impact of this “recast” is likely to be an addition – because the owner takes more out than might be required to replace his services. In some cases, however, owners don’t draw salary, or take much in benefits – even though they work many hard hours on a consistent basis. In those cases the “recast” tally will actually be a likely reduction to pretax earnings. (An independent executive working hard for the company, is going to expect to be well paid for that role.)
In taking that recast pretax earnings level, and trying to give owners a very simplistic way to swag at value, the owner might begin with a flat 5 multiple. This is just a reasonable starting point for an average, profitable manufacturer. It could be slightly less for a construction contractor, or slightly more for a fast-growing pet product or a patented medical device. Such multiple of earnings starting point would be “a conservative norm for” what a buyer might expect to pay for a company to buy all assets, and all liabilities, except interest-bearing debt. (Also, if cash is above normal operating needs, the seller can normally add that to value also.) Then numerous other factors will likely bump up (or suck down) that multiple in total, depending upon what is happening in the business.
The following listing is just a swag at what differentiating items might do to overall multiple values, for a quick assessment of potential impact on your company:
Sales over $50M – add .5
Sales over $100M – add 1.0
Sales under $10M – subtract .5
Sales under $5M – subtract 1.0
Profitability above 18% of sales – add 1.0
Profitability under 5% of sales – subtract 1.0
One customer with more than 50% of business – subtract 1.0
Recurring customer sales < 25% of total. – subtract 1.0
Long term contract with customers (2 or more years) for 75% of sales. – add 1.0
Patent protection for 50% or more of sales – add 1.0
Growth trend over past 2 years above 20% – add 1.0
Growth trend over past 2 years, negative – subtract .5
Strong second tier management, with non-competes in place – add .5
Net equity at 25% of sales or more – add .5
Net equity at 10% of sales or less – subtract .5
Of course these aren’t precise measurement tools, but they are directionally pretty true, and can help a lot to get a reasonable “estimate” of what your value is doing. In every case, a good, strong competitive process can make a huge difference in what you might achieve. The number of competitive buyers, and the intensity of competition can literally double the price or more. Nonetheless, this gives a fair way at approximating value, and good solid developmental targets to improve these indicators will, in every case, pay off when the time comes!