Every once in a while we’ll be chatting with someone about engaging on a valuation project and they decide to go the “DIY” route. “We decided we’d do the valuation ourselves.” How did they manage this? Just like a diagnose all my health problems, of course. They googled it.
Which brings me right over to this little article that I stumbled upon: “Separating Unicorns from Reality: the Value of Business Valuation.” Dispensing with the point that the article is just all over the map, they do manage to throw out some valuation formulas, Quoting:
- “Capitalization: most small businesses can figure a multiple of 3 ½ to 4 times gross annual earnings to determine market worth.”
- What businesses similar to yours are worth, usually stated in terms of gross sales times a multiplier.
- Owner benefit. Similar to capitalization, it multiplies one year’s discretionary cash flow times a 2.2727.
Basically my reaction is: whaaaaa?
First of all, there is no one-size-fits-all way to value “most companies.” It’s not like buying a hat. I like to tell people that valuing something – anything! – really comes down to pricing risk. To the extent that one company (or investment) has a similar risk profile they would have a similar valuation metric.
Second, businesses are simply not usually valued based on a gross sales multiplier. Sometimes? Sure. Usually? Heck no. Here’s why: Widget Maker A generates $10m in revenues and an annual loss of $2m. Widget Maker B generates $10m in revenues and $2m in profit. Other things being equal, would you really pay the same price for A or B? (If you’re answer is yes come see me after class… I have A’s for sale all day long…)
Finally, “discretionary cash flow times 2.2727?” That is totally made up. Seriously, they just wrote down a number with some decimal points and said “sure – let’s use that one.”
Getting to My Point
This was an actual article on the internet. From a site called Business.com, which one might believe knows something about something. But if our almost-client were to rely on this article to value Widget Maker A above, they might think their business is worth:
- A multiple of $10m in revenue
- -$7m to -8m
So basically- a small range of $18 million in potential value.
The internet wins.