Tag Archives: valuation

5 Things Entrepreneurs Need to Know About Valuation

Back to Fundamentals, Business Financing, Business Planning, , , , ,

Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.

  1. The word has vastly Different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
    1. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
    2. What a business is worth to a buyer. Small businesses go up for sale with  business  brokers. Hardware stores, for example,  get about 40-50% of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
    3. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50% of your company, you just proposed a valuation of $2 million.
  2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
  3. For Small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like  recent growth,  and discounts for negatives like lack of growth. You could read up on it in bizbuysell.com, bizequity.com, or business brokerage press. Or do a web search and check the ads for valuation experts.
  4. For Startups, it’s what founders and investors negotiate. Startups and investors and culture clash over valuation.  Investors care about valuation. Founders often misunderstand valuation. And never the twain shall meet. I’ve seen these kinds of problems many times:  Founders walk into the valuation discussion full of folklore and fantasy like stories of Facebook and Twitter. They want lots of money for very little ownership. Investors see two or three people with no sales history thinking their dream startup is already worth $2 or $3 million.
  5. Irony: sometimes traction, and revenues, make things worse. It’s easier to buy the dream than the reality. The same investors who’ll seriously consider a $2 million valuation for a good idea, business plan, and a credible 3-person management team – but with no sales ever — might just as easily balk at a valuation of $600,000 for a company with three years history, 20% growth, and annual sales of $300,000.  Despite the irony, it makes sense: few existing businesses are worth more than a multiple of revenues, but, still, before the battle, it’s easier to dream big. Or so it seems. I’ve been on both sides of this table, and I don’t have any easy solutions to offer.

If it hasn’t come up yet, it will. Every business deals with valuation eventually. The place any business sees it is during the early investment phases; but most businesses don’t get investment, so they can ignore it at that point. But then if it survives, or grows, valuation comes up again, because even if the business is immortal, the people aren’t: so eventually you either sell it or pass it on to a new team, an acquiring company, or your own family. And there’s the divorce and estate planning elements that require valuation. So every entrepreneur and business owner should have some idea what it is.

(Image: courtesy of wordle.net)

Q&A: Valuing a SaaS Business

Q&A, Weblogs, , , , ,

This question was posted on my “ask me” page on my timberry.com site. I can’t promise to answer all the questions I get, but I try, and I’m particularly happy when I get one whose answer might be useful to other people. So here’s a question:

Do you have any idea how to value a SaaS business? Do we use our users, growth in users, revenues, margins, or what? What do investors like to see?

My answer: I’m probably a bit biased on this one because of my position in Palo Alto Software, which publishes our LivePlan SaaS offering for online business planning. But I can’t say I haven’t thought about it. Here’s what I can do to help:

  1. I really like How should you value a SaaS company, posted a few months ago by Robin Vessey and then edited by Joel Spolsky on OnStartups. Joel knows software. You’ll see there that it’s about a variety of factors, usually done on a case-by-case basis. It’s a combination of baseline revenue multiple, market potential, value of the technology, and what’s needed to take it to the next level. This is a good discussion.
  2. Notice that Robin and Joel don’t even mention profits or margins. High-tech companies are almost always valued on growth and revenues, not profits. I explained why in profits are overrated here on this blog.
  3. I read recently that publicly traded SaaS companies are valued at 5-20 times revenues. Publicly traded means that their stock appears for sale to anybody on a major stock exchange, which makes them inherently different from the smaller startups. And, unfortunately for you and me, we smaller private companies take a discount on the numbers of the big companies because we aren’t big and our stock isn’t liquid and we don’t have to publish financial information. Even there, however, it’s still more about growth and revenues than profits. A SaaS company showing strong growth and breaking even or losing a bit does better than a SaaS company with profits and stable.
  4. Investors vary on revenue vs. growth in users. I’d say that revenue is much better than just growth in free users, but then look at Twitter and Facebook and the like, which got huge valuations first for huge user bases and then only later for revenue models. So that’s debatable. When I read a business plan I mistrust user numbers that aren’t tied to revenues, because that’s too easy.

What really matters is the future. Valuation isn’t what something is worth, but rather what somebody will pay for it. So what really sells, in SaaS, is its future. There’s nothing better for valuation than indicators of growth in paying users, stories that tell about market need, and a team that can push it. And it’s magic. There’s no MBA algorithm that applies.

 

5 Things Entrepreneurs Need to Know About Valuation

Back to Fundamentals, Business Financing, Business Planning, , , , ,

Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.

  1. The word has vastly Different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
    1. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
    2. What a business is worth to a buyer. Small businesses go up for sale with  business  brokers. Hardware stores, for example,  get about 40-50% of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
    3. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50% of your company, you just proposed a valuation of $2 million.
  2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
  3. For Small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like  recent growth,  and discounts for negatives like lack of growth. You could read up on it in bizbuysell.com, bizequity.com, or business brokerage press. Or do a web search and check the ads for valuation experts.
  4. For Startups, it’s what founders and investors negotiate. Startups and investors and culture clash over valuation.  Investors care about valuation. Founders often misunderstand valuation. And never the twain shall meet. I’ve seen these kinds of problems many times:  Founders walk into the valuation discussion full of folklore and fantasy like stories of Facebook and Twitter. They want lots of money for very little ownership. Investors see two or three people with no sales history thinking their dream startup is already worth $2 or $3 million.
  5. Irony: sometimes traction, and revenues, make things worse. It’s easier to buy the dream than the reality. The same investors who’ll seriously consider a $2 million valuation for a good idea, business plan, and a credible 3-person management team – but with no sales ever — might just as easily balk at a valuation of $600,000 for a company with three years history, 20% growth, and annual sales of $300,000.  Despite the irony, it makes sense: few existing businesses are worth more than a multiple of revenues, but, still, before the battle, it’s easier to dream big. Or so it seems. I’ve been on both sides of this table, and I don’t have any easy solutions to offer.

If it hasn’t come up yet, it will. Every business deals with valuation eventually. The place any business sees it is during the early investment phases; but most businesses don’t get investment, so they can ignore it at that point. But then if it survives, or grows, valuation comes up again, because even if the business is immortal, the people aren’t: so eventually you either sell it or pass it on to a new team, an acquiring company, or your own family. And there’s the divorce and estate planning elements that require valuation. So every entrepreneur and business owner should have some idea what it is.

(Image: courtesy of wordle.net)

True Story: Why We Bought Out Our VC Investors

Venture Capital, , ,

It started in 1999. We had already grown Palo Alto Software from zero to more than $5 million in annual sales in five years, without investment. But valuations had gone crazy, and our bplans.com site was already getting millions of visits every month. So we decided to look for venture capital to grow the company and sell it.

The boom seemed temporary, and we decided to take advantage before it waned. We had a sense of a very large open window that was going to close.

But we were too late. We signed a deal early in 2000, just a few weeks before the dot-com bubble burst. Very quickly we saw our web properties, which had been worth tens of millions of dollars, settle into more realistic valuations. And more realistic wasn’t interesting to us. We didn’t want to sell the company for what it was worth in 2001, based on sales multiples. We had wanted to sell it in 1999, when valuations were based on website traffic.

Which left us and our investors with incompatible goals. They wanted to flip the company, while we wanted to build it, grow it, and keep it.

We liked our investors. They believed in us, wanted the same thing we did, and offered useful suggestions. They were smart, honest, and respectful. But we ended up with minority owners who wanted only to sell the company, and we no longer wanted to. So we negotiated a deal, and bought their share back from them. That was in 2002.

The buy-back deal wasn’t easy because we’d spent the money to grow and didn’t keep it liquid. But we didn’t want minority investors to be trapped in our company with no hope of a near-term liquidity event.

It all worked out. We still see them on occasion, and they are still friends. But it is one good example of a case in which you don’t want incompatible goals in the ownership of your company.

Big Mistake: Business Plans And Investor Returns

Business Plan Contest, Business Plan Marathon, Business Planning, Weblogs, , , , ,

Another problem that comes up a lot as I read on with my business plan marathon: too many business plans are taking too much time and effort telling supposed investors what their supposed return on investment will be. This is usually a waste of time, energy, and space. It’s certainly a mismatch between what the entrepreneurs are thinking and what the investors are thinking.

fool's goldI was surprised a couple days ago, talking to entrepreneurs, at how much emphasis they put on wanting to know what return on investment was satisfactory to investors. It was as if they thought what the plan says the company will be worth five years from now makes a difference. And it doesn’t. The illustration here is a piece of fool’s gold, iron pyrite.

It felt like these entrepreneurs are thinking: investors want to see X in returns so I have to show that in my plan. I pop up the sales forecast, pop up the profitability, and that generates a great projected valuation. So I show that I can deliver a great return.

Investors, meanwhile, are actually thinking: I want to look at the product-market fit, scalability, management team, and factors like that to determine whether the company is going to make it. If they have all that right, then they have a shot; and if not, they don’t. Projected investor returns depend on a future valuation, which depends on the sales forecast or income forecast or both. Most investors look hard at the sales and profitability projections, because they want to see credibility; I use them to get a feel for how well the entrepreneurs know the business. There’s so much cascading uncertainty on future valuation that I don’t put much stock in it.

There’s a Catch-22 about sales and profitability forecasts: credibility of the numbers means more than the numbers themselves. A plan that has both big numbers and credibility is rare.

(Image: Vakhrushev Pavel/Shutterstock)

BizEquity Adds Tools for Estimating Valuation

Business Planning, Web/Tech, ,

I’ve posted here before on BizEquity, the “Zillow of small business valuation” site offering quick estimates of business valuation.

BizEquity founder Tom Taulli — a true expert in the field — has added some interesting new tools for the site. Most notably, a valuation wizard that can take your inputs and give you a quick and dirty estimate of what your business is worth.

I did a test run over the weekend, by inventing hypothetical numbers for an Internet company. I had it started just three years ago, growing sales to $350,000. It had little or no profits, a bit of debt, and a lot of dependence on the owner (the site’s auto wizard asked me the right questions). The estimate ended up at about $275,000, with interesting variations above and below that depending on how I set several sliders. You probably can’t read the details in the shrunken illustration below, but the sliders are asking how favorable the location is, the level of competition, and how you foresee the future financial performance.

Bizequity input

With the way the sliders work, you can see instantly how valuation would change with different settings.

Obviously, these are just estimates. As with estimates of house values, before you list your house, these estimates give you some idea, but are far from exact. They’re based on some standard formulas that estimate valuation using factors like sales, profits, assets, liabilities, and so forth. Don’t even dream of using this for a tax-related valuation, which requires a certified valuation professional; but it’s still a useful first look.