As the title says. Have a request from a family member to value a small services business; one of the company owners is looking to sell a stake. I have solid accounting knowledge and experience with valuing publicly trading companies but no experience with small privately held companies. Prefer help with someone that has experience in this area.
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Hi Dragon-Ash, any of these discussions helpful:
Hope that helps.
Think you need to be more specific; what's your question? In any case you need a business plan of the company (income statement, required capex, working capital development). Depending on how long-term the strategy plans are, this could be anywhere between 3 and 10y (majority done on 3y BPs).
Important questions: is there a buyer already? Is this growth capital or an exit? Is there interest from a competitor?
How small? What's ebitda? Multiple expansion is a factor...
It wouldn't be much different than valuing a publicly listed company, apart from not having the same level of information. I assume this is a stable, profit making business. Use multiple methods (DCF - then adjust for minority of shareholding, Comparable companies/multiples - and adjust for illiquidity). You may consider there's more risk in a smaller company, so adjust the multiples downwards (for comps), adjust the WACC/Ke with a premium, or put a higher chance on a cash flow downside scenario (for DCF).
The valuation process should be similar to that of valuing of a publicly traded company. However, several adjustments must be made, like what colleague above mentions
I also recommend you finding a similar company to what the one you are trying to value because certain components of the valuation will not be available for a private company (eg there is no beta in a private company but you can use a beta of a similar company or an average beta of comps)
I suggest you have a look at this guide for valuing private companies, it is very academic but I think is very helpful: http://people.stern.nyu.edu/adamodar/pdfiles/papers/pvtfirmval.pdf
Triangulate value with different valuation methods. Assuming you dont have access to proprietary transaction data bases, I would rely on public company multiples and DCF.
With respect to public company multiples, all of the valuation metrics are publicly available (Yahoo finance). Go through 10ks to get relevant operating metrics (revenue/EBITDA) of comps. Try to be thorough in estimating the normalized level (exclude items that are clearly one-time in nature).
Apply a control premium to the range of multiples. Public company share prices are on a noncontrolling basis. Typically, though debatable, there is a premium for control. It could be tricky to estimate this premium, but 15% is usually a safe estimate (supported by various studies).
With respect to DCF, you need to estimate a WACC. Rely on modified CAPM. Pull the unlevered betas of the comps (same comps from public company multiples), take the average or median and relever for the target capital structure. To do this, refer to modigliani miller/the Hamda method (google it).
If forecasts are not provided, build your own. Keep it straightforward and high level. Nothing fancy unless clear guidance is provided. Stable revenue growth, normalized EBITDA margin and working capital levels, etc.
Your DCF value should reconcile to your public company multiples valuation. Apply an additional risk premium to the cost of equity to bridge the two indications of value. This additional premium reflects non market risk variables (size, liquidity, etc.).
I'm skipping a few things but this is the process in a nut shell. Remember that its actual capital structure is not what's relevant. Refer to leverage ratios of comps if clear guidance isnt provided.
I would be much less scientific than this, especially for small, privately held businesses. In private equity, I can't remember the last time anyone asked me to DCF something, as it's quite honestly a useless exercise when you're analyzing how much you can pay for an asset to hit a desired level of returns.
The most important part of your process will be to request access to any financial reporting the company makes for budgeting purposes and figure out what the true level of cash flow it generates is. Figure out how it is growing / growth in the past. Look at growth vs. budget (assuming they have kept a budget of projected growth) to get an idea of how credible management's forward looking guidance is. Basically, you'll do a less thorough but albeit necessary financial due diligence process to get an idea of how the next five years look for the company.
Next, skip all the pseudo-scientific valuation. Figure out what multiple you would have to pay for this business to achieve a desired IRR - set a target for whatever your desired level of returns may be. This will basically be an LBO. There are plenty of guides on how to do a back of the napkin analysis, but it is really quite straight forward.
SME's don't trade at similar multiples to public companies for obvious reasons - lack of control premium, no size premium, higher risk, the list goes on... Therefore, conventional methods for valuing companies will generally lead to overpaying.
Elite_Bulge is correct. You aren't going to go off comps for a company this small.
At the end of the day this type of transaction only comes down to what the valuation is in the mind of the seller. Too often you're going to be up against some emotional attachment/valuation that the seller has that you will need to overcome, and no amount of analysis will outmatch the self-valued sweat equity in a business. You should have some idea of what the company has done in the past, and just assume that the business keeps doing that. It's best to value something like this (since its a services company I assume its CF positive) as a yield on cash flow based on whatever valuation you can get comfortable with negotiating with the seller.
Thanks everyone. All good ideas to help me look in the right direction. It's a small company, been around 10 years. The A-class (voting rights) shares don't pay a dividend. The company is generally profitable, and sales are growing (around $3-4 million in annual sales). Appears to have a bit of a cash flow problem because there's a time lag between when pays its contractors to do the work and when it gets paid, so rapid top-line growth is actually..problematic.
Sadly the financial statements are a bit of a mess. I'd almost like to hire someone to look over them with me to figure out at the very least what questions I need to be asking....
The preceding commenters (mbahopeful and George_Banker) both make great points in regard to the financial analysis and potential emotional angle that will come into play with the seller/family member. Any chance the company has had a valuation done in the last 12 months? To EB's rationale, this could save everyone due diligence above and beyond current requirements to get a deal done.
If no valuation is available or folks want to engage outside assistance, you might look for a firm that focuses on small transactions. Those types may or may not have in-house advisory services consisting of statement review ("declustering" messy info), valuation, and transactional process lead.
Can recommend a couple firms covering the Midwest area and best of luck with the scenario.
I would ignore what the others above said about comp to public companies. Completely irrelevant when you're looking at a company doing $3M - $4M a year in top line.
lol @ the monkeyshit, LMK how many companies you've run/bought/sold in this rev range.
I would agree, but the valuation guys insist on using them. It's mind-blowing to think about how starkly different public companies are compared to this little business services company that almost certainly has some concentration risk at the customer, employee or supplier level. Throwing out some multiple range and assigning some arbitrary discount is one of the silliest exercises in finance, and there are plenty of them.
I'm looking at a PE companys quarterly valuation report for its investments. Lo and behold, public market and transaction comp multiples used to support the selected mark of a small business (micro cap).
It's just crazy to me how fundamentally you guys misunderstand the application of market multiples. Different industry's have their own risk/growth profiles. That's what you're trying to capture/understand when you pull market multiples or, similarly, betas. It's the price paid per dollar of revenue, per dollar of EBITDA, etc.
Like I said, it's definitely not perfect given the size, but it's something. It's a supportable starting point for an analysis that will require certain adjustments by the advisor.
It's certainly better than fictitious unlevered LBO models with arbitrary required return hurdles.
OP is asking what his family's business is worth and your method is not going to get him there at all. Like I said, I'd love to know how many deals you've actually done in the size range or companies you've run/invested in otherwise your advice is completely useless.
Here's why...
So congrats, he can use your method and product something of absolutely zero value!
So this PE Company that you are look at is what size? Certainly not $3-4mm in Revenue if it's in the portfolio of a legitimate firm.
Secondly, nobody is arguing that a formal valuation uses this and would probably be worthwhile in this situation (minority stake of a micro market company) because it gives an independent valuation that will/can be upheld in the court of law. However, valuation reports are academic-based and not reality-based (e.g. expected value if you were to actually sell the business on the open market). If you say the business is valued at 1x Revenue, it will likely trade higher or lower than that because of X,Y,Z.
My criticism was that, on top of the flaws and assumptions in the DCF and transaction comps, public comps provide an even poorer basis for valuation for a business that small because of a multitude of things, including: overall size, demand for the asset, customer/supplier/employee concentration, customer strength, end market diversification, economies of scale, contracts usage/robustness, supplier power, buyer power, liquidity, cost of capital, accounting, IT systems/security, marketing, etc. Public companies are vastly different than private ones, particularly small businesses (this isn't even a MM PE fund's port co.) So, no matter what arbitrary discount you take, it is never going to be scientific. There are simply too many variables.
Exactly. mbahopeful88 should be ignored completely OP. You'll look really bad trying to pitch anything using his methodology.
Still crickets from you bud. What do you propose?
its why hes an accountant
So to answer your first question, the portfolio investment is generating about $20M in revenue and the fund has about an 80% equity stake. Its larger than the company here, but still micro cap by any standard.
Next, and this really the crucial part, valuation methodology doesn't simply go out the window because of a lack of comparability in a few dimensions. That's where the expertise of the advisor can add value. Size does not render the excersise useless, just more complicated.
Next, it's super fucking easy to poke holes in an analysis and not provide any solutions. It's better to have some support of a value rather than a completely arbitrary number based on a made up return hurdle.
In other words, the exercise I described tries to remove arbitrariness, although not perfectly, while yours embraces it fully.
Also, with regard to transaction comps, you can find micro cap transactions, so not sure what your point is there.
Just a few notes about some of the shitpost responses from the hardo buyside guys.
The OP is effectively providing advisory valuation services on behalf of a family member. He is not being tasked with selling the business or with buying another business.
He has not been given any guidance on hurdle rates and leverage doesn't appear to be a relevant factor. As such, an LBO analysis is not useful here. It certainly wouldn't take priority over traditional valuation methodology.
The hardos dont seem to understand the concept of market multiples. They reflect the price the market is willing to pay per dollar of operations. This method is applicable to small companies (may sound funny but think of shark tank. Dont the investors think in terms of multiples when evaluating small businesses?). Of course, you should account for differences in size when selecting multiples, but the method is still applicable.
Transaction comps would be best here.
I agree with most of your sentiment but I do think that IRR analysis is also very much welcome at this party. Ultimately, it comes down to what price does the geezer want to sell at IRR analysis may help them understand their returns and come to a value they feel is acceptable.
Essentially the OP should use several of the fine methods listed in this thread to create a range the seller would feel content with is a fair value.
For something like this, you should start by thinking who the potential buyers would be. And then you figure out what value owning this company will bring to them. Quite often, it will not come down to pure financials; could be the customer base, specific expertise, licenses etc. If you're looking to extract maximum value, you don't want to be just looking at dcf/ebitda multiples/market comps type methods.
What methods do you use/how do you go about quantifying that value (synergies, I'm assuming) to the potential buyer? And then do you bake those synergies/value into the seller company's run-rate EBITDA to achieve the higher sale price?
Why not hire a valuation group? They aren't great at determining real market value, but will give you a valuation, report and third-party validation of whatever value they come up with.
OP DM me. We buy minority stakes and majority in companies in the size range you discussed. We're used to dealing with messy books as well. If it ends up being off target I'm happy to refer you to someone who can help.
Lots of ways to value a small business but public comps won't be one of the methods.
mbahopeful88 you have no clue what you're talking about... stay with accounting; there's a reason you didn't make it to be a buyside "hardo" guys.
This has been just an awful discussion to read through.
The present value of any investable asset is the risk-adjusted, time-weighted stream of future cash flows. Turn it around and read it again: the present value of ANY investable asset is its future cash flows, weighted by time, and adjusted for risk.
The reason it's easier to value bonds than small private companies isn't because the math is different, it's because it's just easier to determine the variables. Evaluating the future cash flows (and their growth) for a small business is hard and ambiguous. Evaluating the risk associated with those cash flows is hard and ambiguous. Evaluating the macro risk surrounding an industry (or value chain segment of an industry) is hard and ambiguous. As such, most valuation techniques are borne out of some way to try and mitigate that ambiguity. Understanding why those techniques work is the only way to arrive at a useable answer in a case where data are difficult to find and opaque, like for valuing small, privately held businesses.
Comps are useful for generalities, but I've been doing this for longer than most of you have, and I've yet to come across a perfect comp. There are transaction dynamics and growth and risk profiles to businesses that don't translate to some other "asset-light business services company" that happened to sell for 9x EBITDA or whatever two months ago. Also, the "triangulation" method is total bullshit; if you need to find a valuation for a niche like a pharmaceutical marketing company, finding 5 pharma companies and 5 marketing companies and averaging them out gives you roughly a pile of garbage.
Your best bet is as a few commenters above described: you have to have some view on the growth prospects of the company independently. Given that, you can look at how the market has valued companies of similar size and future prospects (they may be from the same industry, they may not). If you have all of that, then you can use some discounting framework to have an approximate view on that company's valuation. If you don't, then it doesn't matter what technique you're using, you're just guessing.
Postscript: the LBO method is a totally dogshit valuation method. It's a back-of-the-envelope way to arrive at a willingness to pay for an asset, and you can assume that if multiple sophisticated parties are competing for an asset, then the price paid for that asset may approach the highest bidder's willingness to pay. It can be a useful data point when trying to figure out the limit of what multiple PE bidders might approach in a process, but only as context. On its own, since it completely relies on a totally arbitrary IRR target and ignores the size, growth, timing, and risk of cash flows that we talked about earlier, it is a completely useless way to value a business.
Yes, I'm aware that plenty of PE firms use this as a valuation method. It's a dumb method.
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