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Entrepreneurs the world over have been abuzz with the news that Facebook is kicking off its long-awaited IPO, valuing the company somewhere in the $75 billion to $100 billion range. As part of the IPO process Facebook has at last been forced to divulge that its revenues amounted to $3.7 billion last year, so a quick check of the math tells us that that the company is being valued at a multiple of between 20 and 27 times revenue. Which may lead many of you to ask the question: How much is my company worth?
The short answer—unless you happen to have 845 million users—is, unfortunately, nowhere near 20 times revenue. But don’t let that stop you from coming up with a reasonable valuation estimate, as it will prove extremely useful when negotiating with potential investors.
Valuing a private business—particularly an early-stage one—is a difficult process that requires a blend of art and science, but it is an important endeavor to undertake. Value your business too high and you’ll scare off potential investors and block any exit strategy you might have. Value it too low and you may end up giving away control of your business at a fraction of its true worth.
A good way to begin your valuation analysis is to pull out your financial statements and have a look at your total revenues, your earnings (if your business is profitable), and some other common industry figures like EBITDA (earnings before interest, taxes, depreciation and amortization). If you have a few years worth of financial statements you’ll also want to track the growth rate of these key metrics. Once you’ve got the numbers in front of you it is time to search for other comparable businesses to yours and see how the market is valuing them.
Finding information on publicly traded companies in your industry is pretty easy. Start with a web search for something like “average price to revenue ratio for a hotel” (or whatever type of business you run) and you’ll gain an understanding of how the market values your larger public competitors, as well as which metrics are deemed most important in your industry. Our hotel search quickly reveals that public companies in the industry currently are valued at about 2.4 times revenues (not exactly Facebook territory) and that there are several important valuation metrics that are unique to the industry such as ADR (average daily room rate) and REVPAR (revenue per available room).
Of course, if you are running a twelve-room bed-and-breakfast investors are unlikely to assign the same valuation to your company as they do to Mariott, which has about 3,500 hotels throughout the world. You’re going to have to discount your business significantly to reflect its smaller size and riskier nature compared to the leaders in the field.
In order to gauge what smaller privately owned businesses are selling for there are a number of online “business for sale” marketplaces that you can consult. Try to find data on recently completed successful sales rather than the listing prices of businesses currently for sale, as the list prices can be inflated and not reflective of true value.
Finally, if you are at the stage where properly valuing your business is critical (e.g. you have investors or buyers who are interested) then you’ll want to get some professional help. If you have a good small-business attorney and accountant they can be excellent resources to consult first. And if you need more advice then you might want to hire one or more independent valuation experts to conduct a detailed analysis of your business and assign it an estimated valuation. This won’t come for free, but a solid analysis that assigns a realistic valuation can end up saving you time and money when you are negotiating to sell a stake in your company.
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE’S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.