Determining and Maximizing your Business’ Market Value

How We Determine the Value of Your Business

When getting an investor on board or engaging in an exit process, a key factor is determining the enterprise value (EV) that may serve as one of the foundations of the transaction.

Valuation can be based on historical data and projected future figures. Should you want to sell the bright future, it is always recommended to prepare a detailed mid-term financial plan, so you can capitalize on the forecasted growth.

The valuation approach differs for early-stage companies compared to mature ones, requiring tailored methods. Some entrepreneurs often view company value as the sum of their assets. However, what truly matters is how much cash the company can generate – assets alone do not produce profit.  

Below you find key topics and summaries about enterprise value from calculation methods to differentiating equity value and enterprise value.

1. Science or art?

There is a debate whether valuation is science or art. Obviously, there are exact methods to value a business or an asset (see below). Still, in most of the cases, if we introduce a deal with the same financial plan (excel spreadsheet) and same presentation (e.g. InfoMemo) to sophisticated investors, one investor will say the company worth 20 and the other will value the company… 45! How can that happen? Do they make mistakes when calculating their offers? Nope.

Instead, the first may assess the forecasts differently, the other will “buy the story” and count synergies also. There are many reasons why investors consider a case differently and will be sure what they offered is fair.

At Absolvo, we want to create a situation, where our client’s business is valued more than fair. We are striving to see the valuation is way higher than a financial formula would result.

2. A quick introduction to the different valuation methods.

DCF (discounted cash flow) valuation
A frequently used method that calculates the enterprise value based on the future cash-generating potential. This approach discounts future cash flows to their present value using a discount factor adjusted for the company’s characteristics, risks, and debt levels.

Beyond the discounted cash flows for the coming years, the growth rate of cash flow after the last forecasted year - quantified in the terminal value - also significantly influences company valuation and must be factored in.

It is a more complex method, requiring more financial modelling and forecasting, highly sensitive to assumptions (growth rates, discount rate, etc.), but it is regularly used method as it is based simply on cash generation potential.

Multiples-based valuation
Also a commonly applied method, which determines a company's enterprisevalue by analyzing industry-specific benchmarks and similar previous transactions.

This approach uses financial ratios such as:

• EBIT/EBITDA multiples

• Sales revenue multiples

• The appropriate ratios depend on the company’s industry, geography, market conditions, and size. It is a quick and simple method to apply, useful for benchmarking, but the method is subjective to certain company-specific factors, like growth potential, unique market positions and risks.

Comparable companies and comparable transactions need to be analysed. Specific closed deals that happened previously, where a buyer paid exact amount for a target. Such data (via multiples) can be used as benchmark.

Though this valuation method uses market transactions, but sometimes pricing may contain over- or undervaluation. In most of the cases it is challenging to learn all the details why a buyer paid significantly more than others. One should be careful when applying the multiples or comps methods. 

Comparable companies’ analysis
This is a relative valuation method where a company’s value is derived from comparisons to the current share prices of similar (peer) companies in the market.

Publicly traded companies, market valuation can be used, based on publicly available data.  

The calculated value must be fine-tuned with discounts and premiums, considering factors like company size, market presence, dependency on a single factor, and whether a minority or majority stake is being evaluated.

3. Pre-Money or Post-Money Valuation?

You may have met these expressions also. In venture capital investments, pre-money valuation (before investment) and post-money valuation (after investment) are used to determine the ownership share acquired by the investor. Pre-money value + the amount of investment = post-money value.

It’s crucial to negotiate based on pre-money valuation but calculate ownership shares using the post-money valuation. Do not let investors offer deals based on post-money valuation!

4. Startup valuation

As pointed out, early-stage companies’ valuation should be different, as in most of the cases they do not generate cash and their forecasts are rather concepts than accurate, predictable plans. In many cases there may be forward revenue multiples used (if they have MRR or ARR), or an exit value-based valuation. For Saas startups, a good guide is Chris Janz’s Saas funding napkin.    

5. Enterprise value and equity value

Please do not confuse enterprise value and equity value, and when getting an LOI / NBO then carefully check the numbers offered are EV or EqV. You may read the following: “proposed EUR 54 million on cash-free debt-free basis”. Which is fair as the buyer does not know what the cash position will be on closing day. That is why it is key to distinguish.

And coming back to the definitions:

Equity Value (EQV) = Enterprise Value (EV) - Net Debt (ND)

Equity value equals enterprise value minus net debt, where net debt is defined as debt and equivalents minus cash. For intermediate readers, to be discussed if net working capital is adjusted or not.

6. Can Company Value Be Increased Before a Transaction?
The answer is usually: YES. Value accepted by investors or buyers depends not only on financial metrics but also on qualitative factors such as a clear strategy, strong management, capturing a valuable customer group, having a unique product or IP, as well as measures to address risks.

Meaning, if an investor or buyer will consider such factors, why not to figure these out beforehand and put effort to improve them?

Identifying improvement areas and working on them can significantly enhance value before raising capital or selling the company.  

Therefore it is worth preparing for a transaction well ahead. Adequate preparation can lead to a higher valuation, better deal terms, and a smoother transaction process.  

Some key strategies, actions to increase company value before a transaction:

• Improve Financial Performance (revenue, profitability, cash flow)

• Strengthen Business Operations (reduce management risks, standardize processes)

• Optimize Capital and Financing Structure (e.g. working capital!)

• Strengthen the Customer & Supplier Base (Reducing reliance on a few customers)

• Optimize Tax Structure (tax efficiency, remove non-business-related expenses, items that may lower reported profits)

• IP Protection

• Employee&Management Retention Plans

• Conduct a Pre-Due Diligence

In tech focused deals, where you want to have much higher valuation (and purchase price paid) then a normal financial formula would provide, you definitely need to think 2-3 years ahead and align your product and business strategy with your exit plans.

Last hint: preparing for Due Diligence

‍Thorough preparation for due diligence is essential to avoid unexpected issues that may lower the sale price or affect the equity share in capital increases.