DETERMINING THE VALUE OF YOUR COMPANY (PART 1)
Are you your company’s Chief Value Creation Officer?
When the CFO takes on the role of chief value creation officer, they can uncover critical information needed for future decision-making.
Reed Phillips, Managing Partner, Oaklins DeSilva+Phillips, New York
Charles Slack, business and financial writer
Value creation is arguably the single most important initiative for any company. Yet executives are not always as focused on it as they should be. With all of their other responsibilities, they set value creation aside and assume they’ll get there by growing revenue and improving earnings.
Unfortunately, even healthy growth in revenues and earnings does not necessarily create value. There are many other factors at work. How does your company rank among competitors? Is your industry growing, stagnating or in decline? Do you own intellectual property? Answers to these and other questions about your company’s underlying value drivers get you closer to where you need to be in actually determining your value.
We believe CFOs should think of themselves as chief value creation officers. Since they already oversee the company’s annual budget and strategic plan, they have the skills and resources to direct this initiative, and a regular, detailed examination of the company’s value will in turn strengthen both the budget and strategic plan.
The best way to measure value creation is to produce a valuation once a year. Most CFOs have some experience with traditional valuations. These are typically prepared for specific situations, such as buying out an investor or borrowing funds. The key to traditional valuations is that the work needs to be accepted by the two parties for whom the valuation is being prepared. That requires using an impartial, third-party appraiser.
However, traditional valuations are expensive, time-consuming and complicated. As a result, most midsize companies avoid them unless absolutely necessary. We believe that’s a mistake. The risk of not knowing your value is far too great and can have unforeseen consequences. In working with hundreds of such companies over the years, Reed has seen too many that poured resources into declining business areas, failed to exploit new opportunities or agreed too quickly to an inferior buy-out offer, all because they had no idea of their true value when they needed it most.
We have created a valuation tool that enables an internal team to conduct regular valuations themselves, without the expense and distraction of a third-party appraiser. Our QuickValue methodology involves the careful identification and rating of the eight to 12 value drivers that best define your business. In our next article, we’ll take a deeper dive into value drivers and describe how you can arrive at your company’s Value Driver Score. (Hint: it’s not just about what you do well; a successful and useful valuation also means being objective and honest about the vital areas where your company is struggling.)
Once you know your company’s Value Driver Score, the next step is determining your multiple ranges. Your team will examine multiples of either EBITDA or revenue from 15 public companies in your industry that are similar to your business (we’ll explain why in our article on multiples). Then you determine the range that your value is in and, if necessary, make adjustments for private company M&A transactions.
With your Value Driver Score and your multiples range decided, you are ready to zero in on your value. Here’s a hypothetical example.
Company x has a Value Driver Score of 30% (out of 100%). This is low, with plenty of room for improvement. Company x determined its EBITDA range is between 10x and 20x. When the Value Driver Score is applied to this range, the EBITDA multiple was determined to be 13x, as shown below.
Determining Company x's EBITDA multiple
Knowing that their EBITDA is US$20 million, simply multiply that amount by 13. Company x is worth US$260 million.
With a valuation in hand you, as CFO (and chief value creation officer), now have critically important information for future decision-making. You have established a baseline with which to compare next year’s valuation and to measure your efforts in value creation.
More about Reed Phillips and Charles Slack, and their book ‘QuickValue’
Reed Phillips is CEO and Managing Partner of mid-market M&A firm Oaklins DeSilva+Phillips, and Charles Slack is a business and financial writer. They are the co-authors of the book, ‘QuickValue: Discover Your Value and Empower Your Business in Three Easy Steps.’
View Reed's conference talk on the virtues of valuation for owners of private companies:
More about this five-part series on ‘Determining the value of your company’
Part 2: How well do you understand your company’s value drivers?
Part 3: Finding the multiples that best express your company’s value
Part 4: Unlocking new value for your company
Part 5: Putting value at the center of your strategic planning