How Company Valuations Are Determined & How to Use This Info to Your Advantage

Valuation is one of those topics that seems to come up at the worst times of your life. Whether you’re trying to raise money for your company or get a valuation for your existing business, it can be a painful process.

Depending on the circumstances, this process can be as easy as following a few simple guidelines. It will also be as difficult as dealing with a complete stranger who knows more than you about your business). Valuation is a subjective topic that will always create conflict between any company and its shareholders.

So, how do you tell if the asking price is fair? Or if something is priced too high or too low? I have outlined some of the most common pitfalls and difficulties encountered when valuing your business, along with some best practices so that you don’t have to.

What Is Valuation?

A valuation is a process used to estimate the worth of a company. It is often performed by an outside team that comes in and thoroughly analyzes your business. They go over your company’s financial documents and records to come up with an estimate of its worth. They consider the company’s financials, the industry it is in, and the competition within the market.

If you want to raise money from a venture capitalist or an angel investor, then your valuation will be used to determine the price at which you are offered money for your company. VCs and angels often look for companies valued at $10 million or higher. The valuation of your company will also be used in mergers and acquisitions (M&As).

Why Is Valuing a Company Necessary?

You may be wondering why it is necessary to value your company or why you should even care about how much your company is supposedly worth. The simple answer is that it is a crucial process to determine the next steps for your company post-IPO.

If you want to go public, you need to have a valuation done to ascertain the minimum amount of shares you can sell for. If you are looking for a merger or an acquisition, then valuing your company is necessary.

One of the main reasons why companies perform valuations is to determine the amount of debt they should take on and how much equity they should issue to take on that debt. This is often done as part of a strategic planning process where the company’s leadership looks at various growth options and decides what they see as the best option for the company’s future.

How to Do a Valuation

The following steps are typically involved in performing a valuation:

• Put together a valuation team that consists of accounting and financial experts. You can hire an external valuation consultant to help you with this.

• They will come in and do a thorough analysis of your business, including its financials and the key stakeholders.

• When you approach valuers, they will first consider the market in which you operate, your competitors, and the size of the opportunity in that market.

• They will take all this information and look at your financials and all the key stakeholders.

• They will look at the market in which you operate and the opportunities you can exploit.

• They will then come up with an estimate of the company’s worth and present this valuation to you and your board of directors and see if they agree.

Things to Consider Before You Quote a Price

There are various things you should consider when you are quoting a price for your business. These include:

1) Your History

This will have a big impact on the price. If your company has been in business for a long time, and you have a track record of success, then you can quote a higher price than if it were new to the market.

• What is your company’s track record, and how long has it been in business?

2) Your Team

If your company is only you, then your price will be lower than if you have an entire team of employees that can take the reins when you are away.

• What key members of your team are involved with the running of the company?

• How many others are directly involved in the business versus how many are on the payroll just for prestige or seniority?

3) Your Customers

Your customers are one of the most important factors in determining your price. If you have a lot of high-paying, high-profile clients, then you can quote a higher price than if your business is geared toward small local businesses.

• Who are your customers?

• What is their demographic?

• How valuable are they?

• Where are they located?

• What is their average revenue per customer?

4) Your Products/Services

Your products and services also play a role in determining your price. If you’re selling something that is easily replaced by a competitor, then you may want to quote a lower price than if your business has something unique to offer—perhaps something that is difficult for others to replicate.

• What are the products/services you offer?

• What is the competitive landscape in your industry?

• What are the growth trends in your industry?

5) Your Investors/Investment Bankers

Who are the investors/investment bankers who have backed your company? You may have to quote a higher price if you have a lot of venture capitalists investing in your company. They’ll likely demand a larger share of the profits than an angel investor who has some skin in the game, but not as much risk.

6) Your Key Employees

Do you have an experienced C-level executive on your team? If so, the valuation of your company will likely be higher than if you don’t have someone with that level of experience. It’s also important to make sure that any key employees are receiving equity in the company—if they aren’t, it can negatively impact your valuation.

• Who are the key executives at your company?

• What is the number of years of experience in the company?

• What is the average tenure at each role?

7) Your Market

The size of your market will impact the valuation of your company. If you are a startup that is targeting a very small niche, then you may have trouble getting investors to pay top dollar for your company. If you have an innovative product that can disrupt an entire industry and generate tons of revenue, then investors will be more interested in investing in your business.

• What is the size and growth trajectory of your market?

• What is the adoption rate for your products/services?

• Is there any interest from new customers?

8) Your Financials

Your financials will have a direct impact on the valuation of your company. Investors use financial information to determine whether or not they should invest in your business. If you are profitable, then it is likely that investors will be more interested in investing in your startup because they know that there is money coming in from customers.

• What is the revenue stream of your company?

• How is this revenue distributed?

9) Your Forecasted Growth

Your forecasted growth will be a factor in determining the valuation of your company. Investors want to know that they are investing in a business that is growing and has potential for more growth in the future. If you are able to demonstrate this, then it should increase the interest level from investors.

• How much growth is forecasted for the coming years?

• Is there any evidence that this growth is real and not just a projection?

Some Things That Will Make Your Valuation More Expensive

1) Big Name Investors

If most of your investors are influential or high-net-worth individuals, they will affect the price they are willing to pay for your company. They may demand a premium price for their investment.

2) Equity Dilution

If you issue equity to take on debt, your valuation will be more expensive. This will happen in the event of a debt financing round where you have to have equity dilution to pay back the debt investors.

3) Higher Borrowing Costs

If you have to borrow money to fund your company, then the interest rate you have to pay back will affect the price your investors are willing to pay for their investment.

4) Additional Employees

If you have to hire additional employees to support the growth of your company, then that will also increase the costs involved with running your business.

5) Additional Office Space

If you have to rent an office space or build a new building, that will also increase the costs.

Some Things That Will Make Your Valuation Less Expensive

1) Lower Equity Dilution

If you issue equity to take on debt, then the price that your investors are willing to pay for their investment will be lower. This will happen in the event of a debt financing round where you have to issue less equity dilution to pay back the debt investors.

2) Lower Borrowing Costs

The interest rate you have to pay back will be less than the price your investors are willing to pay for their investment.

3) Lower the Cost of Running Your Business

If you operate at a loss or have lower costs than your competitors, your valuation will be less expensive.

Conclusion

A valuation is an important step for any company in determining its worth. If a company is not valued properly, it can be left vulnerable to financial distress or bankruptcy. A good valuation will also help a company make decisions regarding its valuation and growth.

Several factors will come into play when determining your company’s worth, including your track record and your financials. You should take the time to properly value your company, as doing so can help protect you from financial distress and help you make decisions regarding its growth.

Sources

• LinkedIn: Equity Dilution: What It Is and How It Happens?

• HBR: How Much Debt Is Right for Your Company?

• Knowledge at Wharton: VC ‘Super Angels’: Filling a Funding Gap or Killing ‘The Next Google’?

• Harvard Business School: How to Value a Company: 6 Methods and Examples