The Different Ways to Value Your Company | Mergers and Acquisitions Advice

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Hey everybody, Roland Frazier here. A lot of people that own companies want to know what is my company worth? And that is a very, very big question with lots of answers. The last time I looked, there were like 432 different ways to value a company. So the answer is, truly, nobody knows. The cool thing is, is that really when we know is when we get an offer, that's really when we know what our company might be worth, at least at the minimal initial offer level. The crazy thing though is that like I've had a single deal go from about 25 million initially down to 14 million after due diligence and then close in the 30s. So what was that company worth? Well, at one point to the buyer, it was worth 14 million. At one point to the buyer and seller before they really got to get deep into the negotiations and the due diligence. To look at the company, it was 25 million. In the end of the day it was 30 some million. Right. It was all the same company. Look at the stock market just to get an idea of how crazy valuation is. On one day, Apple's a trillion dollar company. On the next day it's a $900 million company. It's a hundred million or billions of dollars of swings in value in the market. Does that mean that the company was worth 100 million or a billion less the day after it was worth 100 million or a billion more? Absolutely not. Because the market is crazy and illogical. So then we get to, well, how do we know what it's worth? Like if there's those, like if the swings are that wild, how do we actually know what a company's worth? Well, there's a lot of different, like I said, ways to value a company. I think the kind of at the most base level, we look at the accounting book value strategy, which is to say, well, if we took all the assets that the company bought and we add them all up and we take away any of the loans or liabilities that are on those, then that's what the company's worth. Okay, well that, that sounds like that would be pretty, like a pretty good way to figure it out. But what if the assets have gone down in value? Like, what if we paid, what if we bought a fleet of cars and we paid $10,000 for each car, I know it's a cheap car, right? We paid, let's say we paid $25,000 for each car, but now they've, they're all a little bit older, and so they've gone down in value and we could only get 10,000 for them. Should we then lower the value of the company by this reduced market value of the assets? I mean, I, I think it'd be a fairly good argument that, that you should. Well, what if we bought real estate or Bitcoin or some other asset that went up in value? Should we increase the value of those assets to market value to, say, the company's worth that? I think there's a good argument for that, too. So there is an argument that book value or the value of the assets less their loans isn't really an accurate representation of the value of a company. This other kind of competing school of thought is that the company is worth the net market value of all of its assets. So if we had those cars in the company, we'd adjust those down to market value. If we had real estate and Bitcoin and that had gone up, we'd adjust that up to market value. And then the total value of all those assets at market, at current market is the value of the company. But that's not really accurate either, is it? Because what if the company's got a brand like Coca Cola that's been around forever and has huge loyalty? Just the fact that that brand exists creates value. And there are lots of companies on a much smaller level than Coca Cola that have this value. It's called goodwill. The fact that the public is aware of the existence of this company and it has a reputation that at least is good enough for several people to think that they'd like to do business with it, that's worth something. That's what we call an intangible asset, one you can't really get your hands on. And that asset is worth quite a bit. As a matter of fact, there would be a pretty strong argument that the logo for Nike, the logo for Coca Cola, you know, that is worth a lot more than the assets of the company. The logo for Apple Computer. Right. Those are really, really valuable assets that would not be easily determinable. Like, like what is the value of that? I don't know. Because without an open market for it, it's hard to say. There's not like a giant market for Apple's logo, right? But if a company's going to be able to buy that, they're going to pay a whole lot for it because it's worth a whole lot of money. Right. So that creates challenges too. So then the accountants and the finance people say, okay, well what if we look at the company as a whole instead of like its individual assets and adding those up that we say, okay, we realize that all those assets put together with this logo, this goodwill of the company, that's how we should value the company. And that's a pretty cool idea, right? That's, that's a pretty cool idea. But how do you do that? Well, what they do is they say, well, we think that over the next X number of years, the company's going to continue to generate cash flow of the roughly the same amount that it's doing now. And maybe it's going to grow because it's historically grown by 10% a year. So if we were projecting out future cash flows into the future, we anticipate that over the next X years this company is going to continue to produce the cash flow it's increasing now, which is going to continue to grow at the rate it's grown in the past. That there's a lot of assumptions there, but that does get us kind of closer to, you know, what's it worth? And we add all that together and then we discount that to the present value of what that future income would be worth today. That's a net present value, discounted future cash flows kind of calculation. Well, that's another interesting way to value too. Another way would be what is the opportunity cost of having an investment in these assets in this company versus having it invested in other assets in another company? And the only way we can really figure that out is we could look at every company and say, well, here are all the companies we could buy and form a weighted average of them or something like that. But instead what they do typically is they'll say, well, we need to earn a certain rate of return on the capital that we're going to put into this company. And so we're going to call that an internal rate of return or irr. And we're going to let R IRR versus the anticipated IRR of that business help us figure out what the value is. That sounds super complicated, right? You got to know all kinds of formulas. And who the know how, who knows how to calculate IRR anyway other than the old HP12C calculator? So an easier way that is very, very typically employed in most industries these days when you're talking about buying and selling companies, is that we'll look at comparable transactions and we'll say here is a cohort or a group of businesses that are similar to the one that we're thinking about valuing or selling or buying. And here's the price that they sold for recently. So if we get a company that is in a similar industry, that is of a similar size in revenue, that has profitability, that may be greater or less, but let's say it's roughly about the same and, and it's in the same geographic location and so on and so forth. Well, if that's the case, it's, it seems fairly logical to assume that if there's a, a group of companies like that we could put together and several of them have sold not, you know, relatively recently, then this company would be worth that. That's a comparable analysis. So then we're using comps or comparable companies to determine what's the value of this. Well, a lot of times to, to make that even easier, the business professionals will say, well, that group of companies on average sold for a multiple of their profit that was equal to X. So they'll average, they'll say this company sold for a multiple of five times its profit. This one sold for a multiple of six, this one sold for a multiple of four. We're going to average all those together and then we're going to end up with an average of a multiple of five. And we'll just apply that multiple to the profits of other businesses. And in the M and A, in the mergers and acquisition world, we've got two types of profit that we really look at that these multiples can be applied to. One is called SDE or seller discretionary earnings. That applies that SDE applies when we're dealing with owner operated businesses. So we're looking at the difference between what's an owner operated business and what's a professionally managed business. SDE applies to owner operated businesses. And that's basically the bottom line profit. The gross income, less the expenses of the company. But then adding back any expenses that the owner wrote off basically that weren't operating weren't necessary to create profit. They were things the owner just wanted to spend money on. Might be a trip that they call a retreat. It might be a car that they wanted to buy. It might be even babysitting services or cable. There are lots and lots of things that entrepreneurs write off for tax purposes so that they pay lower taxes. Those are not really essential to operating the company so they get added back to profitability for determining ste. The other thing would be that that would be adjusted, would be Maybe the owners paying themselves greater salary than someone who was a professional manager would be paid. So maybe they're paying themselves 300,000 a year, but you could get a really good, high, high quality manager to do what they're doing for only 150. So we'd add that 150 back as well to SDE to get what we call EBITDA. And I'll talk about EBITDA in just a second. The other thing we might do is we might find that the owner isn't paying themselves enough. And that happens a lot too, that they don't pay themselves any salary at all. And it would cost us two or three hundred thousand dollars to get the two or three people. We would need professional management, professionally management wise to come in and do what they do. And in that case, then the money has to be taken out. Like we have to say, well, there should be more expenses here. So we will restate the financials to include the things that aren't in there that should be right and to take away the things that are in there that shouldn't be. Now what that ultimately does is it gives us the industry standard that we use when we have a professionally managed company, which is ebitda and that stands for earnings before interest, taxes, depreciation and amortization. So EBITDA is designed the reason that we're take, we're basically saying revenue or income minus expenses. But the things that accountants do, like depreciation and amortization, that aren't real expenses, that they're not an actual cash outflow, we're going to take those out. We're not going to consider that. And the tax expense that the company had, well, that's not necessary to operating either. We're going to take that out. I mean you have to pay them, but it's really irrelevant to the operating. And then the interest that we incur on debt in the company, that also doesn't really have to do with operations. So ebitda, if you think about it, taking out those things that interest, taxes, depreciation and amortization expense is just designed to say, well, how much money does the company actually make from its operations? What does it actually cost to get the revenue that we've got? What are the direct expenses that are required for operating the business? And that's the number that we then will apply the multiple to this EBITDA number that we either convert owner, operated, seller, discretionary earnings to or that we have once we disregard these kind of either non cash or non direct operating expenses we get to this number called ebitda. And then EBITDA is the number that we apply the multiple that's the average for for sales of other similar companies in the industry to determine what the value is. So our example before was we've got a company that sold for a multiple of 4 times EBITDA, one that sold for a multiple of 5 times EBITDA, one that Sold for a multiple of 6 times EBITDA. So we would add those numbers together. 4 and 5 is 9 and 6 is 15. Divide by 3 to get the average. The average is 5. Now our multiple is 5. Okay. For that cohort or group of 3 companies, our average multiple would be 5 times EBITDA. So now for the company we're trying to value that's similar to those three companies, we would say, what's the EBITDA of this company? We would determine that. Let's say it's a million dollars. And then we'd say, okay, well, then it's worth $5 million. Because the multiple from our cohort companies is five and the profitability over here is a million. Five times a million is five million. That's really how we would go about doing this. So that's kind of looking at, we've, we've, we talked about what's book value and how is that work, and it's not really great. What is market value and is that really good? How do we value goodwill and account for that in these transactions? What are earnings multiples? How do we come up with those? How do we deal with the possibility of future cash flows and discounting those? How do we look at the opportunity cost of our capital and calculate based on IRR internal rate of return? But really, at the end of the day, almost all the deals that we look at, there is a return on capital or a return on investment that the buyer wants to have, and they just look at the financials and say, is this company generating that return? And if it is, as long as it's generating within, within its industry a fair return and that meets their requirement, then they're interested. Now it just comes in. What are they going to pay and what are they going to pay? Typically comes down to, well, the multiple range is between X and Y. And we're only negotiating about that now. You can get significantly more than the industry average. I know, I've done it several times. And you have some people who are buyers that say, well, this is the industry average. So we're not going ab above this ever, and we're not going below this and this. That's where it is. So it's really the easiest way to figure out what your company's worth just to go and find what is the average multiple of EBITDA that companies in your industry selling for, multiply that times your EBITDA or your profit, and then that gives you a pretty good idea of what you're going to get for it if you go to sell it. So that's kind of how we use multiples in this in this world.

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Hey, quick question. Do you know someone who's looking to grow as a leader? Maybe their team is growing a little faster than they expected? Or maybe their new role requires them to work a little bit more through people? If the answer is yes, I want to recommend a new podcast by the Scalable Media Network called Ready to Lead. It's hosted by Richard Lindner, one of Roland and Ryan's business partners, and Jeff Mask, who's one of the top executive coaches in the world. They cover tactical strategies on how to improve as a leader and also their biggest failures they've had throughout their career. You can find the show@readytolead.com or search for it wherever you listen to podcasts.

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