Atlas Private Company Insider

So,...How Much is My Business Worth?

By Chris Andersen

 

For ten (10) years now one of the first things all entrepreneurs ask the principals of Atlas is our estimate of the value of their company.   Our response is always the same “it depends.”  There are a variety of factors that increase or reduce the value of businesses such as: the trajectory of industry multiples; comprehensive analysis of an enterprise’s strengths and the level of development of its infrastructure; as well as the ability to grow the business in the future.  We will discuss each of these and provide an example of how these impact the overall enterprise value.

Valuation is one of the first elements addressed before Atlas will take on an engagement.  As discussed in our last edition, our projected value will determine if we can satisfy the needs of one or more owners so they can “move on to the next chapter of their life.” 

First, let’s address so-called rules of thumb multiples to determine enterprise value.  Business owners often relate a story whereby they know companies in their industry are valued in a range of 6-8 times earnings (as an example).  And, of course, business owners always believe their company should be valued at the high end of the range.  Simply stated this is a method for assigning enterprise value by multiplying a company’s trailing twelve months of earnings before interest, taxes, depreciation and amortization (EBITDA) by some factor. 

There are two major caveats we discuss with our clients when they mention industry multiples.  As shown in the nearby table valuation multiples can, and do, swing wildly from year to year based on market factors.  In addition to overall market swings, valuation multiples vary from industry to industry.  For example, technology companies spent much of the last decade with market valuations at 10-15x EBITDA, while business-to-business product and service companies were in the 7-10x EBITDA range.

Lower Middle Market Deal Multiples

Source: Pitchbook: Decade Report Vol. II

As discussed above valuations for a company in a particular industry also vary.  Why are some companies valued at the low end of the range and others at, or above, the upper limits?  As former operators, and now as intermediaries, this is where each Atlas principals really earn her/his stripes. 

We evaluate and position our clients based on their strengths, versus others in their industry, as well as assess the state of its organizational development.  Strengths of a business can include:

• Differentiated Products or Services  – including any Intellectual Property)
•  Barriers to entry – is it easy or difficult for others to enter the market
•  Key Performance Indicators – how they benchmark to others in the industry
•  Proven Trends & Profitability – has the business been growing on a consistent basis in the recent past or has it at least been steady
• Good Management Team – are the right people in place to help the company grow and thrive
• Repeat Customers w/ Low Concentration – is there a diverse customer base thereby limiting risk of loss of one or more large customers
• High Employee Retention – indicates positive working environment and a functioning management structure

Next we review the company’s internal infrastructure.  This becomes important in M&A transactions as it is a primary driver of the organizations ability to achieve its growth goals.  Specifically, if a business has employees with limited skills, inadequate financial systems and control, antiquated equipment or other areas requiring significant investment (be it time or money) a buyer or investor will discount the value of the business in order to account for the need to improve the organization prior to implementing its plans for growth.

There are other areas in each company that should provide a strong foundation for the company. These are not sexy parts of business, but they are fundamental to keeping the wheels on the tracks no matter what is happening externally in the market.  Such blocking and tackling items such as those in the following list are important:

•  Financial Forecasting & Reporting
• Well-maintained Records
• Strength of External and Internal Agreements
• Documented Policies and Processes
• Mitigated Litigation or Environmental Issues
• Sarbanes-Oxley Compliance

Our final area to be explored is the issue of growth.  Financial investors and strategic acquirers want to be confident the business can grow significantly.  An understanding of whether the company has the ability to innovate and continue to create new products or services or whether opportunity exists to expand into new markets is a key consideration.  Companies with a great niche with significant prospects to increase its market share are considerably more valuable than a business with a defensible position with limited capacity to expand.

Case Study  In the below table we evaluated two Bay Area companies in the same industry.  Company A had been around for more than 20 years and had an excellent reputation.  However, the business was barely growing and the owner had not invested in the business and was running every aspect of the daily operations and sales.  Company B has been in business more than 10 years and also has a good reputation.  The biggest differences were the owner’s willing to share management responsibility and continually working to improve product, processes and efficiencies so he could pass the savings along to customers.  

The net result found Company B was worth nearly $11 million, that is $4.6 million more than his competitor, a valuation that is a whopping 74% higher.

Company A	Company B
Light Manufacturing	Light Manufacturing
Revenue at $10.3M, growing 3%/yr.	Revenue at $9.7M, growing 8.5%/yr.
$1.25M EBITDA	$1.5M EBITDA
Older equipment needing frequent maintenance	Equipment in good condition
$950K inventory (poor controls)	$400K inventory good controls
Loyal employees	Loyal employees
Limited management team	Good management team
Valued at 5.0x  EBITDA,or $6.25M	Valued at 7.25x EBITDA,or $10.88M

We have seen an example of how a smaller (in terms of revenue), more nimble and efficient business is much more valuable than a company in which the current owner is not investing in the future of the business and is.  Now, make no mistake, Company A is still sellable just for a lot less money. 
 

Entrepreneurs should ask themselves “What are my company’s strengths, what else do we need to enhance our growth and what can I do to make my business more attractive to investors or acquirers?”  Business owners that answer those questions will unlock value in their enterprise.  Partnering with the right advisors will help them achieve their goals.

Contact:  For further information please email Chris Andersen: Chris@AtlasCapitalStrategies.com

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