Business Valuation, Math or Science?

As a regular judge of start-up pitches, I've witnessed many types of pitches on stage, some are impressive and some are not. Leave aside the big ideas or uniqueness of their business, the one that often caught me is the way they value their business.

I want to talk about valuation from various angles, just to share my 2 cents.

Let's go back to the fundamentals, what is the purpose of valuation?

1) To raise fund, be it equity or debt, your business value? allow your funder to calculate their return before making the decision (this including all the ECF, IPO or any private placement);

2) Merger & Acquisition, both buyer and seller know how much shares in exchange based on the value of both companies

3) For fun, some people just want to show their business worth, for no specific reason, and just want to have that number as reference, who knows??

So, the objective is really about putting a price tag on your business, and it's up to you to decide whether you want to use that to raise funds or any other corporate exercise.

But is there a fixed formula to use in assessing the value of a business? Obviously, we can't, due to many factors affecting a business. We cannot have one formula that fits all, here are some methods we used for valuation:

A) Market Value, perhaps one of the easiest among all, nevertheless this is only applicable if your business is a public listed company that's traded on a Stock Exchange;

B) Net Assets, one of the most conventional way to value a company, by referencing to the Balance Sheet of the company, this is very relevant when your business have substantial non-depreciable Assets such as land and buildings and other liquid assets (commodity, investment in stock market etc);

C) Historical multipliers, such as X times of your annual revenue or X times of your Profit After Tax, this is by assuming your business is already in a stable state, and the level of revenue or profit is of consistent level, the higher the X simply means the higher premium in your valuation (PE, Price Earning is one of the most frequently used method);

D) Future Profit, often used for new business as there is no historical references;

E) Discounted Cash Flow, another common method used, but instead of focusing on profit, this method focus on the present value of the net cash generated by a business, by using an agreed interest rate;

F) Negotiation, perhaps this sounds like not a formula, but this can be quite an interesting one, a business that has limited value can be improved by someone who has the ability to pivot the business, thus it's a matter of who needed who most, in this case, the buyer often got a chance to get it at a discount instead of paying a premium.

If the method of valuation is math, what's the science? It is simple "factors" that affect the value of a business, why would someone be willing to pay a premium or why someone can negotiate for a discount, and here are some of the factors:

- Purpose, those who are investing in businesses that generate stable income/payout, they probably more inclined to use Present Value (Discounted Cash Flow method) as valuation method, very straightforward;

- Expanding market shares, this refers to the buying of competitors business to expand their revenue as well as clientele;

- Enriched of products and services, for example you are now distributing car brands A, and you acquire a company that has auto financing license, you can now sell cars and provide financing to your customers.;

- Supply Chain integration, this refers to both the up-stream or down-stream integration, for example, you own an F&B chain, now acquiring/invest into a chicken farm, and chicken is one of the most important components in your food costs;

- IPO potential, one of the most sought-after potentials, in which many would give a higher premium to the valuation simply because they have the opportunity to cash out upon listing (of course with an even higher premium);

- Technology, this often seen in mega purchases by tech giants, example Google bought over Waze, Meta bought Whatsapp etc;

- Other reasons such as branding, political or even ESG reasons can be one of the key factors that create premium in a business valuation

Business valuation is still a math and science in my opinion, and logic plays a very important part in it. Many founders believe their business is unique and demanding a high premium and this is not going to work in the long run.?

As I said, there are many formulas and factors involved, so consult the professional before you embarrass yourself when you pitch.