Read Part 1 -> Why Valuations (part 1)
Estimating how much you will have to give up to investors without losing control and/or how much debt can you take on if you are able to meet your growth intentions.
In order to answer the above question, you would have to know the projected impact on your business of the additional cash you will receive from borrowing more money and/or having an investor put in funds. Almost everyone seeking funds have encountered an Angel Investor who wants to put in a small amount to receive control of the company and/or have been discouraged by a bank who did not understand the potential of the business and were unwilling to lend.
What it means is they fundamentally did not understand or agree with how you are valuing the business. And it often means that they do not understand how the story of your business connects with your financial statements. What it also means is that you have to have at least a basic understanding of your company’s capital structure. More simply put, you need to understand who and where your company gets it money from and what is the best way to get more money from them without giving up control in order to meet your growth intentions. This is as complicated as it sounds and involves many variables. Some of them are even counter intuitive. Many Founders turn this over to a professional. Our position is that you do indeed need a professional valuation to interpret the numbers into the story of your business. But you also are the best one to tell your business story.
Debt (Money from Lenders)
If you go without a professional valuation to a bank (lender), they will do the valuation for you, and you are likely to be very disappointed. The bank does not have the story of your business and will reduce your business to the numbers they see in your tax records and management information that you sent to them. From a lenders point of view, a lender wants to ensure that you can pay back the money with interest and if you don’t, they want to ensure that they can get that money by selling off whatever collateral you used to borrow the money. In addition, the lender usually has a long list of criteria. But the most important one is past cash flow from existing assets. Because lending often involves paying back money before you have a chance to go through your business cycle and receive the impact of the newly infused cash, most banks have the criteria that if you cannot pay back the money from existing revenues or cash reserves, you are not a likely candidate.
Equity (Money From Investors)
Going to an Angel Investor without a professional valuation more likely than not he is going to under value your company because it is to his or her benefit for you to have as low a value as possible and then get a greater share of the company. The fact is that whether you are borrowing money or bringing on new investors before you begin the discussion with the potential funder, it’s best to have some idea of what your company is worth in its current state and what it would be worth if you were to use the funds towards your growth targets. However, it’s really difficult to do a back of the envelope valuation analysis of your company even if you are an accountant.
To get money from a lender or investors you need a valuation that people trust. You also need a valuation that can stand up to the IRS or in court if there are any disputes to ownership. Think of it like having an independent appraiser if you were selling land and/or a home. All parties involved can begin the negotiation from that price point. Getting a valuation for real estate however, is easier than getting one for a private company. The reason being is there is a lot of public information available on how real estate trends and actual sales. This data has to be reported for tax purposes, etc. So, there is a lot of comparative data as to how much things are worth. Whereas with a private company. there is almost no reliable data and comparisons have to be made with similar public companies.
There’s nothing straight forward about a valuation of a private company. According to the National Association of Certified Valuators and Analysts (NACVA) a professional evaluation involves financial analysis, normalizing the historical earnings, analyzing the economic and industry conditions and forecasts, and evaluating the company’s internal and external risk factors, then the analyst can estimate the future benefit stream. That’s quiet a mouthful. Many business owners’ eyes roll over when I explain this to them, so over time LDFH developed a methodology of asking a series of questions in order to come up with better valuations. Sometimes these conversations took place over extended periods of time, due to the business owner not having the information on hand.
What to do about all this complexity?
So, what’s a business owner to do to get at least a ballpark figure to begin to get a valuation and negotiate for cash infusion through debt and equity? Some people have turned to AI tools like ChatGPT. While ChatGPT is a good place to start it requires training on asking the right questions and interpreting the answers. Other valuation companies provide online valuation calculators. In my experience not all valuation calculators are created equal. Some use an earnings model where they compare the earnings with similar public companies and provide a multiple. Let’s say they say your medical practice should sell at 2 to 4 times Earnings Before Interest Depreciation and Taxes (EBIDTA). Others use a revenue model. They ask you to anticipate your growth then compare the revenue with similar public companies. With this multiple in hand the tool will tell you what they think should be the value of your company.
Both above answers fall short for various reasons. The primary reason as they need to look at the health of the whole firm as it grows. At LDFH we developed a tool that incorporates the best information about your company’s existing equity structure, its existing growth structure how increased borrowing and the taking on of investors is likely to affect value. From this the Founder is able to play with growth, debt and equity to produce a likely range of value. This has the effect of the Founder gathering and inputting the various information as well as better understanding the correct mixture of debt and equity his or her company can handle to achieve the desired growth. After this he or she can have a more meaningful consultation with LDFH, not only on how to interpret a valuation, but also as to which factors can increase the value of the company.
After trying our valuation calculator at LocalDealFlowHub.com, it’s time to reach out to LDFH and get an official assessment and valuation that you can use to raise the money you need.