Guest blog by James Boorman, Project and Corporate Finance Advisor and Founder of New African Projects and Business Ltd.
In the latest of a series of guest blogs that look at issues around financial management for women entrepreneurs, this week our focus is on understanding how to value your company. I want to sell 25% of my company to a friend - just how much is my company worth?
That is a very good question but to get a proper valuation of your company you must call in the professionals. I shall however give you a good idea of why one or another approach could be better for you.
If you have a huge business with vast turnover, massive cash flow and impressive profits, chances are high you will have intelligent accountants, eager advisors and a Bank that will all be very willing to suggest many solutions. If you do not, then please read on !
Experts will tell you there are many ways to value a company, but in the end these are all based, to a greater or lesser extent, on a combination of these three ways.
The Asset-based Approach
If you have any age to your company, this is not for you (unless you are loss making and can’t see a way out…). Net Assets (Assets minus Liabilities).
If you make beautiful Handbags in a factory that you own, on machines that are yours and take these handbags to market in your own truck, the combination of all four is worth far more with you creating value and jobs than selling the individual parts - just the factory on its own looking for a buyer in a quiet village? Machines lying idle with a ‘For Sale’ sign on them? An old pick-up truck at the local garage and your inventory, now 1000 miles from Nairobi with only the local market for company…? That is why the Asset-Based Approach usually brings in the lowest valuation (if an Uncle of yours offers to buy your company for less than this, ask questions !). However, as the earliest possible valuation it does work - you have just started your business, about to turn on the machines and your friend walks in...
Income Approach
If I were to buy your company, I wouldn’t be buying it just for its Equity (Assets - Liabilities, as above), I would be buying it because I believe in your business, I am convinced that the Profits will grow, the Cash Flow will continue, Turnover will increase and I will be able to retire comfy into my old age. These are all future items, dreams and expectations - how can you translate those into a price that we can both agree on ?
The Income Approach via Discounted Cash Flow (DCF) tries to bring that into the equation…
DCF implies that a company is worth all of the cash that it could make available to investors in the future. Please note it is ‘Discounted’ cash flow because cash in the future is worth less than cash today - think winning the Lottery - you would want your US$1,000,000 winnings today, not US$1,000,000 paid out in 10 years time.
Please note there are many variables involved, if any of these are wrong or changes then the valuation will change - in some situations significantly, hence my warning that professionals such as Auditors should be brought in to assist, but it does allow you to sell your company based on the expectation of the future - a future you have built and therefore should rightly share in.
Finally - Market Approach
Really quite simple in concept - the exact copy of your house sold for Kshs 1,000,000 yesterday, yours will be valued there as well. Obviously no two businesses are the same and the products although similar will differ in some way (Coke or Pepsi ?), but this gives you a very good guide indeed to where your company should be valued - someone else has done the hard work and working on the age old view that something is only worth as much as someone is willing to pay for it, this is a very good guide !
Next week - The Dark Side to Compound Interest and why you need to keep your friendly Banker in the loop.
James Boorman, 22 years in the Financial Markets in London trading many different products from FX to Interest Rates to Commodities to Futures and Options, before being relocated by Credit Agricole in 2007 to Johannesburg as an Investment Banker, Head of their Financial Institutions Department, sub-Saharan Africa. He now spends his time with his family in South Africa whilst advising on Project and Corporate Finance deals. He adds significant value in the foreign exchange value chain to those companies who do not have the necessity or resources to justify a full time Treasury professional or department, but still need to ensure that their market risks are managed (and their sleep patterns undisturbed). Seen here planting Bamboo in Mozambique.
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