By JB Henricksen
The main reason a company wants to increase its valuation is for the benefit of the owners. Current owners looking to raise capital would like the highest price possible. Owners who eventually want to exit the company and monetize the value of the company would like to sell at the highest price possible. Owners only benefit from increased valuation when the company is sold or if there is a transaction exchanging ownership. If there is no transaction, it is just a paper increase that sounds nice because your company is worth a lot, but you have no liquid value. Bill Gates was wealthy from his Microsoft stock, but he was able to buy the things he wanted and create the Gates Foundation with cash generated from selling his stock.
Valuation can mean different things to different people, but in the end, it is what a willing buyer will pay a willing seller. Valuation companies use many different methods to value a company: A multiple of revenues; A multiple of recurring revenues; A multiple of net income; A multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization); A multiple of Free Cash Flow; Discounted cash flow and many more.
The obvious answer to the question of how to increase the value of your company is “sell more at a higher profit.” Sounds easy enough. Different industries are valued differently and different stages of growth are valued differently. I am not going to get into all of the details of valuations, but even with a SaaS company that is valued off of monthly or annual recurring revenues, the company still has to be generating a profit or generate cash flow in order to increase the multiple. Many companies in early stages have losses, but are still valued highly, because of recurring revenue that is “hoped” to generate cash flows for the owners in the future. So, your start up may be valued higher based upon revenues in the early stages, but even Google and Amazon had to start showing some cash flow to maintain their value.
If we assume a company understands it has to make a profit and generate cash flow, what else can a company do to increase their value or to increase the multiple used on revenue and profits? That is the bigger question. How do we increase our earnings multiple or our revenue multiple? There are a few basic items companies can do:
1. Get your financial house in order.
This means have accounting records that are clean and accurate. If you are looking to sell, you should really anticipate having an “audit” of your company financials by a CPA firm. Start with a strong accounting staff or outsourced accounting role. A few years before your audit, you should consider a much less expensive “review” of your financials by a CPA firm. It will help make the audit transition smoother and less expensive. It will show your investors you understand the importance of your financial statements. Through the years I have heard from PE firms and VC firms over and over that companies will have a higher valuation multiple if their financial house is in order.
2. Create a strong management team.
One of the most successful investors in the State of Utah is Jim Dreyfous. He often said he looks for three things in an investment: 1. Does it work?; 2. Is there intellectual property?; 3. Do they have strong management? Number 3 is the most important of the three. Investors like to invest in teams who have a proven track record of success. So, even if you are brand new to being an entrepreneur, surround yourself with some strong people. You need strong leadership in operations, finance, sales and marketing. Strong leadership is not cheap, but you can attract talent on a part time basis and or with the possibility of equity in the company.
3. Plan for the long term.
It’s an old rule of thumb, but a good one. “Build your company like you are never going to sell, but be ready to sell your company at any time.” Companies are more willing to pay a higher premium if there’s a clear road map to achieving higher returns down the line. Sellers need to clearly understand what bidders expect from the sale and deploy the right strategy to help achieve the buyer’s goals. Some buyers might expect a certain return over five years. If you don’t have a road map to that return, then you’re not going to get paid a whole lot for your business. You will need to provide high-quality, substantiated, quantitative and qualitative financial forecasting that can indicate future results. If the math doesn’t add up? Keep improving the business. It’s like exercising — you can run a six-minute mile or a seven-minute mile, but if you want to do better, you’ve got to tighten up, time yourself lap by lap and introduce measurable metrics. Ultimately, if you can improve your business to a point where a buyer can see the potential for sustained growth, you’re likely to command the price you want.
About JB Henricksen
JB Henricksen, CPA, MBA, is a partner with the firm of Ampleo (formerly Advanced CFO), an outsourced CFO and controller firm that has been serving the business community for over 20 years. JB is also an associate professor at the University of Utah.