How much is your business worth? The answer to that question depends on the reason you are asking.
One method to value the equity in a business entails estimating the future cash flows available to shareholders and dividing those cash flows by a discount factor, which is estimated based on the risks the business faces.
The value produced by this method could get you to an estimated value of 100% of the equity in the company, depending on the cash flows. In the valuation profession, this is referred to as a control level of value. This amount can be useful for internal decision-making purposes, such as allocation of capital, how much debt funding should be used, evaluation of potential acquisitions, and other similar issues.
Dividing the estimated value of 100% of the company’s equity by the total shares outstanding will get you to a value per share. However, the owner of a single share could face legal restrictions on the ability to sell that interest and might have no say on the dividends he or she will receive. Therefore, discounts to that per-share price for lack of control and lack of marketability might be appropriate. The discounted value of a share can be useful for buying out minority shareholders (depending on the circumstances), setting the price for new shareholders to buy in, or for estimating taxes when a minority stake of the company is gifted. This is referred to as a non-controlling, non-marketable level of value.
You might hear about a local competitor who recently sold a business for a relatively high multiple. That multiple applied to your company might produce a value higher than the control level of value previously discussed. That is likely if a strategic buyer who considered synergies when establishing an offer price bought your competitor. That value would represent a strategic level of value.
How much of a premium you could get above your control level of value depends on who wants to buy your company and what synergies they think they can get by integrating your operations into their business. Synergies could be in the form of additional revenues from cross-selling into the combined company or cost savings from streamlining redundant operating expenses. A buyer may also add a premium for the value they see from eliminating a competitor through horizontal integration, or by improving logistics in the supply chain through vertical integration.
It is important to note that you cannot realize a strategic value without giving up control of the business. The buyer might make significant changes to the business, including laying off employees who might be people you have known for years and with whom you have developed strong relationships.
Depending on the reason for your valuation, you can reach different valuation conclusions. If you would like to discuss your valuation options, please reach out to us.
In the next issue, we will discuss measuring and tracking returns on your business and why doing so is important.
