Imagine you are going to sell a house and it is expected to fetch you around Rs.75 Lakhs. In the current stage, it may not be maintained properly. Suppose you are spending around Rs.2 Lakhs to get the house painted well and necessary maintenance works are done. This may fetch you an additional Rs.10 Lakhs once it is put for sale.
Similarly, a higher valuation for a business can help the owner in many ways – to get a higher price when it is sold or to reduce dilution. For any fundraising plan, dilution is based on valuation of the company. The more value a company has – the lesser the dilution and vice versa. In this context, many entrepreneurs ask the question – How can we improve the valuation of our business? There are various financial and non-financial factors which contribute to valuation
1.Analyze your financial statements:
Dive into your financial statements, understand what contributes more to your margin. It is interesting to note that not every component of your revenue generates profit. As mentioned in Pareto rule (or 80-20 rule), understand what segment contributes more to your profit margin. Nurture that more. Diversifying your revenue will help in achieving the goal – planning for profitable products or geographies which generate more margin are also options to explore.
How do you increase your margin?
Difference between selling price and costs denote your profit margin. Costs can be reduced, either by automating routine tasks or reducing unnecessary overheads.
Prepare a budget, stick to your budget and this will help in enhancing your profits while achieving your growth plan.
2.Understand valuation aspects:
Valuation may be done by various internationally accepted methods such as net assets method, discounted cash flow (DCF) method or multiples method based on the nature of your business or a combination of various methods. If it is discounted cash flow method, cash profits will be considered. Understand how to maximize cash flow. This can also be achieved if you reduce your collection period or if you get more credit period. There are various methods to compute valuation based on the specific characteristics of the business.
3.Increase your assets and decrease your liabilities:
This is mostly applicable for asset based companies. However, keeping liabilities at the minimum would enhance the value for all business. Expanding business to strategic locations will also have a significant impact while increasing your business presence and consequently, your assets.
4.Understand the challenges in valuation:
Valuation is an art more than a science and hence the level of subjectivity is more. Challenges in valuation mainly refers to the difficulty in convincing the investor regarding the valuation. Also, valuation is valid only for a point of time, it will be for a specific purpose and it will keep changing based on the activities of the company, industry movement, and many other factors.
Many cases, investors will have concern regarding valuation done in DCF method, as this is based on management projections and hence it will be on a higher side while comparing with the thumb rule.
How can you convince the investor in such scenarios?
- Please ensure that the projections which you are mentioning is realistic and it is substantiated by sufficient analysis or research.
- Do a sense check to ensure that profit margins are within the industry standards.
It would be very interesting to note that many companies which are in loss have raised funds at a significantly higher valuation. How do they achieve that?
This usually happens when an investor perceives value in the growth prospects of the company.
5.Assess your valuation periodically:
It will be ideal to assess your valuation periodically, so that you can analyze your valuation and identify the key drivers. This will be helpful to prepare for the valuation well in advance and not to wait until the investor comes. This will help in getting a better valuation.
6.Risk factors in valuation:
While computing valuation, various risk parameters will be assessed. This includes:
- The trend in which the industry is moving – More value comes to a business in an industry which shows a growing trend. In some other cases, company may be performing well, but industry is on a declining trend, which may cause uncertainty regarding the long term performance growth of the subject company. This in turn could result in increased risk of business and lower valuation.
- The capability of the promoters – Capable management always adds to the value of the business. Many investors prefer companies with a strong team, rather than a company with only one promoter. A capable management with a revolutionary vision and achievable mission are important aspects.
- Corporate governance – It is important that all documentations are well in place and legally complied.
- History of your company – This involves identifying how your company has been performing in the past and to understand if there are any pending litigations or any other factors which needs to be considered.
7.Identify your strengths
Companies with first mover advantage or a strong Unique Selling Point (USP) will have better value than companies who follow the crowd. This emphasizes the importance of a scalable and strong business plan.
8.Find out what is the return:
You need to think from an investor’s point of view as well. The investor will be more concerned about the growth of the business and the returns he can generate from it – either as dividends or on exit. If your business has the potential of getting a good exit valuation, investors will be more interested and it will generate more value for the business.
Considering our earlier example of selling a house, now you have painted the house and all maintenance works are done, documents are proper and you are ready for sale. Ultimately, price is decided through negotiation.
Likewise, it is the negotiation between the investor and the company which turns out into a successful transaction. There are various other factors also, which should be kept in mind. The structure of the entity must be checked if it is compliant to receive foreign investments. Else, necessary steps need to be taken to correct the same. It is always better to get professional advice for valuation, so that various related aspects can be taken care of with ease.
Now that you have done a lot of things to improve the overall performance and presentation of your organization, then negotiation will be open. By then, do your homework and prepare well regarding industry scenario, external factors which could have an impact (e.g. value of INR, share market) and industry benchmarks. From the company perspective, you should be aware of the transactions in your industry so that you will get to know the minimum benchmark which you should keep in mind. Give the best presentation of your business before the right investor at the apt time with finest preparation/knowledge. Wish you the very best.