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How much is your start-up worth? Ordinarily, the thought process on business valuation is that there is a level of profitability to which you are applying a multiple and you arrive at your price, whether that's debt free, cash free; it's an enterprise value, an equity value. If you jump in like this you are making a mistake, because at the heart of everything in a business sale sit six factors that drive value.
Quality of income varies across businesses. Say one business secures a deal worth £2 million in profit. In another, however, you have two million events through which you have generated a pound of profit for each of those events. The quality of income in the latter is far stronger than the former.
It's all about the resilience of that income and that business model. And that's why when you're looking to start a business consider the quality of income. For example, if you are prospecting for oil, it's quite binary. You're either going to find it or you're not. You might find it to a different degree. You might find more, but that's not a business model which in itself would generate value.
Visibility of income, is how clearly future income can be seen. If a business has contractual revenue, on the day of acquisition, the acquirer knows that they have a book of business. If a buyer can see what the income will be, that visibility is a very big catalyst for an enhanced multiple. It’s very rare that a vendor will settle for some form of asset valuation. You want some goodwill, and that is driven by what the future's going to look like.
Imagine two recruitment firms. One supplies temporary staff, another finds chief executives for permanent roles. The first firm has 60 temps that are sitting in RBS being paid £600-a-day and the agency is taking 15% margin, which is secure. However, if you are recruiting for permanent roles, even if you have placed several CEOs in the past year, the buyer has nothing contractually committed and there's no visibility of future income.
A credible opportunity map is arguably the most significant driver of value.
If you plot multiples versus years and take three different lines, one being a high growth business, one being a medium growth and one being flat. What the valuation trends will tell you is everything converges at about a two and a half, three times multiple in year two or year three. So, Amazon might be making a pound of profit now and be worth $100 billion. No one's paying a 100 billion multiple. But what the analyst is saying is, it's going to make $300 billion in three years’ time. It's about the growth rate, but it's a credible growth rate that comes from how that opportunity map works and where you can get to.
“A credible opportunity map is arguably the most significant driver of value.”
The opportunity map is making sure that you demonstrate to an incoming investor that this initiative is going to work and it will work going forward. Because otherwise it is just talk about how many million ways a business can improve. You need to have done it but you don't need to have done all of it. In fact, you do leave that to the purchaser, but you do enough to demonstrate credibility.
The most common reason people come to Bluebox is the need for distribution and this is where sell side synergies can drive value.
If you are selling off to some big producer, what by definition you're saying is, this is more valuable in their hands than it is in your hands. So if they buy it, it's going to turn it into this, and therefore, they get some of the benefits of the work that you've put in, but you want some of that benefit as well. So on the basis that there are competing acquirers you split the difference with the acquirer. A company with the right distribution partner will sell more.
Quite often we have clients who are generating a 60% gross margin. Our first response is, that's great, but big margins are also a big flag to competition to say this is an attractive market. So your margins need to be defensible and stable. Ask yourself, do you have a barrier to entry in the market these could be a brand, regulations, first mover advantage, relationships or a long-term contract.
Strength in management is harder to articulate to an acquirer but it does offer two main benefits. It should support your pricing and allow you to generate a better price. But secondly and critically, it opens up a whole new universe of buyers - the private equity community, they want to invest in hungry and ambitious teams.
Not only does the management give any trade buyer, in most cases, an argument to say, we like that there's a stronger, driven management team. It won’t increase the multiple but it does give you a halo effect and helps you avoid situations where you can't sell.
Entrepreneurs need to interrogate their business models, ideally when it's the seed of an idea. Because you will know from that stage, which markets are going to be attractive and what the business should look like.
We often see entrepreneurs with a skill set and the ability to identify an opportunity, grow their business, put in place a strong team, but they are oblivious to the factors in a business model that drive an exit value.