Company valuation: how much is your business worth?

There are many situations in which it is important to determine the enterprise value. An investment, a business transfer or a conflict between two shareholders. Very decisive for the final amount of the enterprise value is the valuation method you use.

Content:

1. Reasons to perform a valuation
2. Determine enterprise value
3. Methods to calculate enterprise value
4. Pitfalls with a (too) high company valuation
5. Calculate your company value yourself

1. Reasons to perform a valuation

Calculating the enterprise value always plays a role in situations where shares are transferred from one party to another. Here you can think of:

• Merger, acquisition or business transfer;
• Shareholder dispute;
• Economic and fiscal disputes;
• Divorce;
• Inheritance.

2. Determine enterprise value

Especially in the transactional practice of selling a business or a business acquisition, one of the first questions that often comes up is: what is the business worth? This question is difficult to answer because there is no universally applicable formula for determining business value.

Good to know: there is a difference between the enterprise value and the price paid for a business. The value in use is a number that is the outcome of a particular valuation method used to determine the value in use. Price is the amount the buyer pays and is the outcome of a negotiation process. Price and enterprise value are usually not equal to each other.

3. Methods to calculate enterprise value

There are roughly two approaches to arrive at a company value: methods that mainly look at historical figures and methods that focus on future cash flows. There is something to be said for both methods, and in practice a mix of both is often used.

Company value calculation based on historical figures

This method for calculating the enterprise value mainly looks at the past. The advantage of this approach is that it quickly gives an initial indication of the business value. The disadvantage is that the future of the business - and that is what the buyer is primarily interested in, after all - is hardly considered, if at all. In general, this method of calculating enterprise value leads to simple formulas such as:

• 5 x net profit
• 0.75 - 1.5 x the annual turnover
• 3 x EBITDA (= earnings before interest, taxes and depreciation on fixed and intangible assets)

The main disadvantage of this method is that the enterprise value is based entirely on past results. But as with investing, these offer no guarantee for the future. Moreover, it does not consider other factors that can be very decisive for business value: how dependent is the business on its owner? Are major investments needed in the short term?

Calculate enterprise value on the basis of future cash flows

This method for calculating the enterprise value mainly looks at the future earning capacity of the business. This method is called the discounted cash flow method(DCF method).

The DCF method is not about profit (= an accounting concept), but about the current future cash flows (cash); the money that actually flows into the business. This includes future investments, launching new products, outsourcing production, etc. The future cash flows this generates are then discounted (discounted) at an interest rate consisting of a minimum return requirement + risk premium.

To determine the risk premium we look at qualitative factors that influence the final company value:

• Dependence on management;
• Dependence on buyers and suppliers;
• Market position of the business;
• Distribution of entrepreneurial activities;
• Access barriers.

With this, the DCF method not only provides insight into the enterprise value, but also shows how this enterprise value can be influenced.

4. Pitfalls with a (too) high company valuation

It is very tempting to dream of huge sales proceeds, and many sellers do just that. But without disappointing you, it is wise to take a moment to consider the following three pitfalls:

1. One-sided seller perspective
2. What is the buyer's perspective?
3. What about fundability?

#1 One-sided assumption of the seller's perspective

Their company has been making two tons of profit for years, they also take home a ton of management fee per year, and at the tennis club they hear that their business is easily worth seven times that profit. So they do the math: 7 x 300,000 is 2.1 million euros, and they enter the sales process in good spirits.

Conveniently, they forget for a moment that the buyer must also have a salary, so that ton of management fee must be excluded from the calculation. Then comes the next reality check: based on the characteristics of the business and the industry, it turns out that the business is not seven times, but at most four times the profit. And so the value drops from the hoped-for 2.1 million euros to 800,000 euros. Not exactly an amount to carefree retirement from.

What is also common is that sellers step over a few bad years too easily, but a buyer will base their offer on the current status of the business and what they can do with it, not on what it was worth in the past. Whatever amounts you have in your head, whatever fancy calculations you make, in the end only one amount really matters, and that is the price the buyer is willing to pay for your business. That amount may well be a lot less than the dreamed-of "value" of the business. You may think your business is worth five tons, but if the highest bidder only has three tons for it, that is the reality you have to live with. But fortunately, the other way around also happens.

#2 The perspective of the buyer

Most valuation methods primarily assume the seller's point of view. After all, if you follow the methods obediently, you will base the future estimates needed to determine value on your own business plan. But for a buyer, what you intend to do with the business and what it is worth to you is really not relevant at all. No, a buyer wants to know what it is worth to him.

#3 What about fundability?

As a seller you can choose the highest value as a starting point for negotiations, although the question is whether that is always wise. As in the housing market, too high an asking price can also deter buyers. Especially in times when banks are cautious about providing loans, fundability is an important aspect in arriving at the purchase price.

You can have a well-founded asking price of 2 million euros on paper, but if the intended buyer with his own resources and a bank loan does not come beyond 1 million, that is still the reality with which you enter the negotiations. Insisting on 2 million cash for 100% of the shares is then rather pointless. To close the deal, creative solutions will soon have to be sought, such as a subordinated loan, phased sales, an earn-out arrangement and other variants.

It is therefore very important that you have a picture of the financial possibilities of the buyer as early as possible in the sales process.

5. Calculate your company value yourself

In order to calculate the value of your company, Brookz has developed its own company valuation tool which provides you with an indicative valuation of your business within 5 minutes!