How to value a Business?

When banks turn down your loan application, you are deaf to the reason of rejection and the only feasible option left to save your company is by inviting investors to ease your working capital in COVID crisis. If not for cash injections, you had to turn to a moneylender who would make you suffer higher interest payments. The problem is that you don’t know how much shares to give to your investors, and what to say and what not to say to them, because you do not know the valuation of your company business value
You tried to control yourself not to be overwhelmed when you heard someone you know has sold their business for more than 30 million. Since you are in the same industry, you see that as something impossible. In view of the revenue, profitability and establishment of your business, you realise yours is anytime bigger than their business – so this means, you may also do the same? You start to fancy a way to value your own business, with the wants of retiring with more money than them.

Why do you need to put a value onto your company? Is it important to you if you are in business for more than five years? Or is this just as important in startups as well? Hell yes, your business would be able to attract the right talent to grow your company; no matter the percentage of shares, they would feel the sense of belonging – don’t you think they will love their job even more? With the right valuation, you could easily land a strategic partner with cash and resources to help bring your business to the next level.   

Simon is a social media influencer who can sell anything online. He is charismatic and dearly loved by his fans. He could brilliantly share anything and become viral in a blink of an eye – from junk food to lifestyle, and even from the knowledge of law to the principles of engineering. Simon attended seminars about equity funding and got fascinated by the idea of using other people’s money to build an empire business of influencer marketing. His motivation led him to meeting up with angel investors, whereby they bought his idea and asked how much investment was needed and how would they be able to obtain their shares. After further discussions, he was stunned and as they could not agree on the business value and percentage of shares requested by the angel investors.

Simon came across a venture capitalist (VC) who was willing to listen to Simon’s offer.The VC could not believe the value Simon has put to his company as it was unrealistic, and the VC straight away turned down his offer. Simon never gave up and decided to hire an accountant to prepare a projection. He tried to get hold of another VC again, unfortunately he was still unlucky. After the fifth time being turned away, Simon met a CFO from a networking dinner and Simon had no clue this was the answer that could change his fortune forever.  
The CFO showed him what he needed to do before getting investments for his startup, and it was equivalent to getting married. Equity funding is not a bank loan application; instead, it is exactly like dating or a job interview. Nobody could tell how much their salary is without knowing their capabilities to perform, and nobody would ask what do you think your value is. This is just the same as asking “Can I have the highest pay in your company? But I am not sure if I can deliver what you want”. Therefore, the most important thing you need is getting your valuation right – to know YOUR value in the dating market. 

Business valuation is a process and a set of procedures used to estimate the economic value of your interest in a business. Business valuation provides information to assist with planning and investor strategy. Other than reporting, it is also a critical component of all corporate transactions such as mergers and acquisitions, corporate restructuring and corporate recovery. There are various methods to value a business, and for SMEs it is near impossible if you have an infinite mindset of running a business. You might think “I never thought of selling the business, so how should I know what its price is now, or even in the future?”.

Almost everyone who starts a business does not have a timeline to sell or hand over his business to a successor – just like a king does not know when he wanted to retire until he actually dies on the throne. Don’t get me wrong, an infinite mindset is good for businesses and this theory was supported by Sinek, author of ‘The Infinite Game’. Sinek pointed out that running a business is a journey without a final destination. The goal is not to win but to keep playing, by which he means building an organisation that can survive its leaders. That requires making decisions that sometimes impede conventional entrepreneurial imperatives, such as growth at any cost.

Before you apply any valuation method to your business, you need to have a direction, a road map. “Begin with the end in mind” is one of ‘The 7 Habits of Highly Effective People’, a bestseller by Stephen Covey. In its most basic form, it refers to always having the image of the end of your life as your frame of reference to evaluate everything else. When you think of the image, do you have the numbers? You may or may not see it in your future timeline and it is alright, you can flow back to now until you can clearly see the numbers. But will it be realistic to others? You see, these numbers are important to you and not others. You have to make sure you have picked the right valuation method for your business – one that would give rise to a valuation which represents your business perfectly.

Common Methodology

The first category of valuation method is known as Common Methodology.

1. Multiple of Revenue
Revenue per annum is multiplied with the number of times to determine the value of the company. It is a generally accepted approach for the world of venture capitals and private equities.

1.5 (Multiplier for mid-sized accounting firms) x 1,400,000 (Annual Revenues) = 2,100,000 (Business Value)

2. P/E ratio
The Price/Earnings (P/E) ratio or PER is a ratio for valuing a company that measures its current share price, relative to its per share net earnings. This method is often used to value companies with an established profitable history. Thus, it is not applicable to startups.

3. Discounted Cash flow
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. DCF analysis attempts to figure out the value of a company today, based on projections of how much money it will generate in the future. This is commonly used for project-based businesses.

Bespoke Methodology

The second category is the Bespoke Methodology.

1. The Notice of Assessment Method (NOA)
A notice of assessment (NOA) is a statement sent by any creditable bodies detailing the amount of contract value that would be incurred. Such details are useful for investors to accept an estimated value of a company.

2. The Paid-Up Capital Method
It is also known as an asset based approach, considering how much did the business owner put into the business. It is usually done on liquidation basis or going concern. The balance sheet may not always have all the significant assets or the registered share capital like the company’s methods of conducting business and internally developed products. The actual value would be higher than all recorded assets of business.

3. Founding team’s past successes
The lineup of the founders of the company could have brand effects to make a company more appealing to investors, especially when the founders are well-known in the industry. Hence this valuation could benchmark their previous success fundings track record. With this, founders make a company more valuable due to the contribution of their expertise and skills set to drive the company’s mission.

Based on the methods in both categories, you can see that the easiest way to value a company is by the ‘Multiple of Revenue’ method. The rest of the methods would require sound judgement from experts to value a company. Therefore, here, we would place thorough focus on the ‘Multiple of Revenue’ methods.

Or it could further broken down to,

Or a similar approach would be,

To further understand this method, I will illustrate it using an example.
Let’s say a company had RM5 million revenue per annum which generated a profit before tax of RM1 million a year. The company can be valued at RM5 million multiplied by 5, that is, RM25 million. The number here is 5 – but why is 5 used and not other numbers? It would depend on what industry you are in. Of course you would want the highest possible you can get since you are selling; but on the other hand, your buyer would want it to be reasonably low as possible. Once the numbers have been decided on, the founders could then offer perhaps 10% shares to new shareholders who inject additional cash of RM2.5 million to help bring the company to the next level.

What if you do not have any revenue, as you are just a startup. My advice is, please do not value your business solely with a pure idea. Without any traction, no investor would feel safe entrusting their money with you. Raising funds is raising a believer – starting with users that believe in your prototype, is traction. Simon had millions of social media followers, and that is awesome traction. However, his first valuation that got rejected was using the Top-Down valuation method, i.e. offering 1% of a USD1 billion market. It was a huge mistake done by Simon in the earliest stage of trying to obtain investors. When dealing with a venture capitalist, this certainly was nothing but a stupid move.

Another wrong approach to value a company is by pegging to the competitor’s valuation, “Because a unicorn is worth X amount of value, hence my company should be worth at Y amount of value.’’. Simon hired an accountant and financial expert to value his company using financial projections was also a wrong approach. You see, smart investors will never bother to look at your financial projection; you can only attract angel investors but you will be stuck if your valuation is too high in the beginning.
Simon pathed his funding road map out with the help of the CFO he met, and described in detail his pitch deck on an equity crowdfunding platform. He resonated his vision as per the road map, to his fans on social media. Successfully, within seven days he managed to raise RM2.7 million. With an infinite business mission and sufficient funding, Simon brought his business to the next level.

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