Category Archives: valuation

Business value

What is it really?

Bus valueWhenever you are looking at an investment in a private small business or a large public company, or if you are selling a business, it is always a challenge to define the value.

Everyone leans on the price-to-earnings multiple, but it is never that simple. Simple to calculate, but not easy to get it right. Earnings are $250,000 per year and a P/E multiple of four means my business is worth a million. Sounds reasonable, right? Well, try selling it at that price and you will find that buyers will argue to reduce both the earnings number and the multiple.

If you look at public companies and the financial analysts’ valuations, you will find they disagree on both past earnings and the forecasts of future earnings, as well as the multiples to be applied. Why is Amazon currently valued by the market at 247 times current earnings and TD Bank at 13 times? (And your business at only three times?)

This is where everyone quotes Warren Buffet (so I’ll do the same). He looks for value based on the “sustainable competitive advantage” or “economic moat” which protects the business from its competitors. That value comes from the intangibles which support high expectations of future growth and low risk of losing market share to competitors or new entrants. Those intangibles include brand name, patent protection, customer loyalty, intellectual property, strategic relationships, creative and innovative organisations, a long history and a good reputation. Some investors and advisors, like the Motley Fool, insist that their best investments have been because of visionary leadership which has consistently seen new opportunities, adapted and delivered solutions. They are thinking of Steve Jobs at Apple, Jeff Bezos at Amazon, Elon Musk at Tesla and other visionary leaders.

So remember to look past the numbers and the simple calculations. Real value is driven by the things you cannot calculate, but you can evaluate. Use your imagination and make the leap of faith.

Be better. Do better.

Your Uncle Ralph, Del Chatterson

Visit LearningEntrepreneurship.com or contact DirectTech Solutions at www.DirectTech.ca for assistance on your strategic business issues, growth and profit improvement plans or your exit strategies.

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The weird WWW continues

Back when we were first introduced, about twenty years ago, it was called the World Wide Web.  Now it would be better described as the Weird Wonderful World that we live in.

It is a continuously and rapidly changing world that affects us all every day.  From the time we wake up to check e-mail and the weather on our smart phones, staying connected all day for work and play, until watching old movies or TV series on Netflix before bed. The internet has become as much a part of the infrastructure we take for granted as traffic lights and coffee shops.

But taking it entirely for granted is not a good idea, since it is a continuously changing infrastructure. Suddenly, the most popular app is not available on your Blackberry and the old accounting software is not compatible with Windows 10.  You’re in danger of going obsolete yourself if you don’t continually replace or upgrade devices and software. Suppliers are constantly developing products and services to win new customers and build attraction to their brand. Marketing gurus find ways to make them irresistible and impossible to ignore.

But the suppliers also live in this challenging world without control over events. In the news again today, we learn that Yahoo continues to search for a strategy that will allow them to survive. Remember them? The original Web portal that asked “Do you Yahoo?”  Now we are all Googling and Facebooking instead of Yahooing. What was once creative and exciting, now seems old-fashioned and obsolete.

Twitter_bird_logoEven more recent successes, the so-called unicorns that grew rapidly from zero to billion dollar valuations, are not guaranteed longevity.  Consider Twitter. Another weird concept launched in 2006 that caught on and has grown to 320 million active users. The company went public just over two years ago before it was even generating any significant revenue. Enthusiastic fans drove the first day share price to $44.00 for a valuation of $31 billion and it rose as high as $69.00 in early 2014.  That little bluebird is now fluttering under $18.00 and management is saying “We have a ton of work to do in crafting the message to the world what Twitter really is and how you can use it” (FP, 18-02-2016).

This weird and wonderful world continues and we still cannot understand or explain it.

Your Uncle Ralph, Del Chatterson

 

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In recent mandates with several different clients, we have gone through the exercise of valuing their business.

A few important principles were confirmed:
  1. The value to the owner is unique to that individual. Ego may artificially inflate the price, but more importantly the role and relationships established by the owner may change drastically with his/her departure and thereby affect the price.
  2. Value is always determined by an evaluation of the future income relative to the uncertainty or risks associated with obtaining the expected returns. Regardless of the valuation method, (P/E multiple, payback period, or discounted cash flows) the forecast future income stream has to be solid and the known risks have to be reduced to get the best possible valuation.
  3. Current owners tolerate more risks, uncertainty and “fuzzy” circumstances than new owners/investors. You may be OK with the fact that you are dependent on one key supplier because he is an old high school buddy; or that you have no signed lease but the landlord is your uncle; or that your best sales rep is also your only son and he wants to be president. Prospective buyers will be much less enthusiastic unless those issues are all resolved to their satisfaction in advance of any offer to purchase or invest.
  4. Different buyers will accept different prices, terms and conditions. The prospects usually range from the passive investor looking for a reasonable return for reasonable risk; to the active investor who sees the potential to do better than your forecast under his own management; to the strategic investor who sees even greater opportunity in buying a competitor, supplier or customer and merging it with his existing business to increase revenues, eliminate unnecessary overheads, and substantially increase profits. The selling price will increase accordingly.

For more on the subject visit: http://www.directtech.ca/pricing_a_business.htm