How to Value a Company

Most business owners eventually deal with the issue of their company's worth, whether in establishing a strike price for options or in trying to sell or raise money for their companies. Stating the obvious, the value is what a willing buyer would be willing to pay and a willing seller would accept. That said, business owners are often understandably frustrated when they see the lack of objectivity in determining the value of their business. Unfortunately, like valuing baseball cards, valuing a business is less of a science than an art.

This is not to say that valuations do not have mathematical explanations, nor that there are not industry starting points (as discussed below), but all of that is academic without a willing buyer or investor making a real offer. Using the right advisors, particularly valuations experts, can add to your bargaining leverage, ground negotiations on both sides, offer a variety of creative methods and financing options, and introduce new potential investors.

There are several well-accepted methods of valuing a company in both an investment and a capital raise context. Buyers and investors often use one of the following valuation methodologies: (i) a negotiated multiple of EBITDA (earnings before interest, taxes, depreciation and amortization); (ii) a discounted cash flow analysis (which is often used in the leveraged buy-out setting where acquisition debt payments need to be covered from free cash flows); and (iii) market comparables (where comparable businesses are identified and their stated valuations are used as a basis, and differentiating your business may be the primary point of negotiation). A good valuation expert can help identify other valuation methods that would be most favorable to your company.

The different methodologies rarely have the same outcome. The above methods are all attempts to create some kind of baseline which can be useful to both buyers or investors and sellers.

The Private Equity Overhang

The Alliance of Mergers & Acquisitions Advisors and PitchBook Data recently released a study of the private equity industry. The study showed that there is an overhang of approximately $400 billion in private equity fundraising. That means private equity firms have raised about $400 billion more than they have invested. There's a lot of money out there waiting to be invested. In fact, it's at an all-time high.

As tough as times have been, people have continued to give their money to private equity funds. The funds just haven't found companies that they consider good investments. So what needs to happen? According to some, it's a matter of companies lowering their expectations. Companies can no longer expect to get the kind of multiples or the kind of leverage that were used before 2007. Others say it's all about the stability of the economy and the re-opening of the credit markets. Still others say that investors need to change the way they do diligence on a company. The old methods will no longer work in light of the current economic realities.