If you own or manage a mid-sized company, do you have a firm grasp of value? Now, at this hour? Do you know for sure how much value you generated last year? Can you figure out where your business value is created and where it is lost?
If the answer to any of these questions is “no,” you may be putting your company’s future in serious jeopardy.
Recently, one of us (Reid) recommended a family-owned company that operates three separate business units, each in a different industry. Two of the divisions are doing well in promising industries and the third is lagging behind in a declining industry where prices are too low and impossible to recover. Unfortunately, instead of devoting most of their time and energy to making well-performing businesses better, management was trying to fix a struggling business.
The damage done in this way became clear only when the company was sold. Because the three business units were in different industries, the sale involved three different buyers. The top performing businesses earned $75 million each. The struggling business — which received their attention — grossed just $12.5 million.
Imagine what the value of a combined company could be if management focused on improving businesses by investing in innovation, expanding the customer base, improving quality, and so on. Within a few years, a targeted growth strategy had improved already promising businesses and made buyers willing to pay a 25% premium each, or $100 million each, rather than $75 million. Even if those investments required closing a third business, the $50 million increase in market value would have more than offset the cost of closing one bad business.
While any company can make mistakes of this nature, family businesses are more at risk. The emotional connections to their rich histories and cultures (often among their strongest assets) can become liabilities if leaders stay too long or resist accepting new directions. Clear and objective reviews of such companies provide important reality checks.
Unfortunately, most owners and managers of mid-sized, privately held companies (family-owned and others) operate day-to-day without a clear understanding of their value. Because busy executives assume that there is no easy way to determine their value, they simply put the issue aside. Unlike their publicly traded counterparts, they don’t have the benefit of automated daily valuations based on stock prices, nor do they have standing teams for corporate strategy executives to analyze value creation. Many midsize company leaders view third-party reviews as complex, time-consuming, intrusive, and expensive. Thus, they are treated only when they are needed – for example, when they need capital for growth.
Despite these challenges, if you own or manage it, it is imperative that you conduct a detailed review at least once a year. Think of it like your annual physical—an important step in figuring out what’s going right, and more importantly, what might be going wrong. Then you can take corrective action before it’s too late. You can avoid wasting precious resources with the wrong customers, trying to grow areas of your business that are necessarily shrinking, and underinvesting in areas where you have the greatest opportunity. Additionally, if you are approached by a buyer interested in purchasing your company, you will be ready to respond and negotiate. Instead of fishing for some hazy “X times EBITDA” figure you heard at your last industry conference, you’ll have a clearer idea of what it is. yours Company – not only those such as Yours is worth it, and why.
A more accessible assessment method
To make the valuation exercise easier and more accessible, we’ve created a new method called QuickValue. It draws on Reed’s experience working directly with hundreds of middle market leaders to help them understand what their companies value and why. Your internal team doesn’t need future financial projections to perform this kind of self-directed assessment—most of what you need is already on hand, and you can easily find what you don’t have. Your company’s executives know the business better than any consultant, and they don’t need to bring anyone on a learning curve.
Our approach to this exercise emphasizes a close analysis of your organization’s most important value drivers: those characteristics that make your business unique. Even companies in the same industry and with similar metrics can differ in everything from the quality of their management to pricing power to brand equity. Therefore, a careful, thorough and honest assessment of these value drivers is essential to calculating the value of an individual company.
First, you identify the value drivers that are most important to your business – we recommend choosing eight to 12 – and score each one from zero to 10, with 10 being the best value driver for you to create results. This score forms an important part of your evaluation, as it measures aspects of the quality of your business that most other evaluation methods ignore. Then you and your team use market value multiples of public companies to assess the value of businesses similar to yours. Finally, if you’re a privately held mid-cap company, you’ll need to settle for lower multiples (typically lower than 25-30%) for M&A transactions involving private companies.
The next step involves bringing it all together. Getting the three critical pieces of data – an assessment of your value drivers, your EBITDA multiple and adjusted EBITDA – takes some hard work, after which, a simple simple calculation yields the number you’re after: clear, well-supported value for your business.
This evaluation process allows you to:
- Avoid selling your business at a discount.
- Better focus on how you can improve your company by maximizing your value drivers.
- Create a strategic plan with innovation as a central value.
- Incentivize your employees based on the value they create rather than using revenue or EBITDA targets.
How to know if it is worth it
Consider the following hypothetical example. Company X has been approached by a competitor with a buyout offer. The price, the competitor says, will be based on a widely used industry multiple of 12x EBITDA. The two companies are in a fast-growing industry, and both are performing well.
Fortunately, Company X’s managers recently completed a valuation of their company, and believe they have a strong and defensible case for valuing their company at 18x EBITDA, not 12x.
How did they get there? An internal team of four senior executives covering major disciplines – Finance, production, marketing and production – They worked together debating which value drivers were most important. The team determined that drivers such as supply chain and franchisor-franchisee relationships are more important to their growth and success than their software business, such as intellectual property, leadership and pricing power.
They then rated themselves on each driver using a scale of zero to 10 and gave extra attention to the drivers they thought were especially important. It was a spirited, frank and revealing discussion. They took care to judge themselves well, including the drivers who did well and the drivers who needed improvement. They combined these rankings to reach their total score of 112 out of 140 points. Although the group recorded only 10 value drivers, one was considered critical and received triple weight (30 possible points), two were very important and received double weight (20 points), and the remaining seven had a standard 10 points. . Using our system, they received an 80% value driver score (112 points divided by 140) – a very high score given only to the best companies.
Next, they examined the EBITDA multiples of 15 public companies in Company X’s industry. (In this case, an investment banker they know provided this information, although there are many ways to gather it quickly.) This allowed them to develop a range of valuations, which they then revised downwards slightly to account for differences between the public and the public. Private company M&A multiples. The range of 10x–20x EBITDA is where the company will find its value once it uses X results. The company’s strong point puts it at the high end of the EBITDA range at 18x, as you can see in the table below.
If Company X had been acquired at the competitor’s bid, it would have been a bargain for the buyer. That’s because companies selling at 12x EBITDA have very low scores.
By not accepting the offer, Company X has one shot left. The $10 million in EBITDA would value the company at $180 million (18x EBITDA), $60 million more than the offering.
It should be noted that the hypothetical story above presents a better scenario. Not every company guarantees such a commendable result, and that’s why we use the word “protection”. Exaggerated self-assessments are quickly discovered during any buyer’s due diligence. After all, self-deception is counterproductive to this exercise, because you don’t come away with information that you can build on. If an honest review results in a low price for your business, that’s disappointing, for sure. But it’s invaluable information you can use moving forward to make your company stronger.