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Funding For Your Business – Worth More Than Money!

Cultivate relationships with established early stage financing sources, through Angel Investors, Capital Finders, or Venture Capitalist. Even if you never raise a dime from any of these sources, as an emerging entrepreneur they are worth to you their weight in gold. In fact, they have something more valuable to you than mere capital. It’s their deal inventory. So what’s valuable about deal inventory?

What’s it worth to you to have first knowledge of the newest and soon to be hottest applications in your field? Could that knowledge give you a huge jump on your competition? Could some new technology enable you to do something no other competitor can now do? Could access to this technology enable you to introduce a new product or service within a time window before anyone else can do it?

I take time every few months to talk with those individuals that I have come to know over the years who have been prolific at either financing or finding financing for companies pioneering new technologies. For the price of a phone call and 30 minutes or so of mutual updating on our current projects, I am consistently introduced to young companies that have developed a technology that can enable me to eclipse my competition.

This past week, I was introduced to a new company with a revolutionary way to digitally color and pattern fabric. They have one name brand account for whom they produce in volume and are hungry for more business. Because of the way they imprint the fabric and fuse dye with material, a clothing designer can economically create clothing designs that would be utterly cost prohibitive under any other existing method.

Imagine the reception by buyers for major department stores when I show them at the next trade show a clothing line priced 40% less than what comparable style and quality would normally cost. What an opportunity to introduce a new line of clothing from a new designer!

And, what if we’re too successful? How do we finance production? We take orders at the trade show for delivery several months later. We’ve lined up the manufacturer ahead of time as well as the lender, a factor and even some small investors. Once we have the orders in hand, everyone is happy and ready to play their part with minimum if any risk.

How Much is Your Business Worth?

There are 3 basic approaches to value your business: the Asset Approach, the Income Approach and the Market Approach.

The Asset Approach is based on the principle of substitution. Meaning, it assumes that no prudent buyer / investor would pay more for a particular business than the cost to reproduce it right across the street. The main flaw with the Asset Approach is that it does not do a good job of capturing intangible value (goodwill). How you (and your employees) treat your customers and the reputation you hold in the marketplace is not something easily duplicated (and therefore valued with the Asset Approach). So, beware of the limitations of this approach. Understand that although an Asset Approach provides a relative indication of value for highly asset intensive companies, it may serve merely as a liquidation value for your service oriented company. The Income Approach and Market Approach do a much better job of fairly capturing the value of your company’s goodwill or intangible value.

The Income Approach operates under the assumption that a buyer will pay for the cash flow that your business is set up to produce going forward as of the date of sale. Buyers buy cash flow. How much they are willing to pay for access to your cash flow depends on the risk associated with the buyer actually receiving it once you exit the business. If your company shows a consistent history of steady cash flow and/or growth a buyer is likely to pay more for your cash flow stream (less risk) than for the cash flow stream of a similar company with unstable cash that cannot reasonably be assumed to reoccur in future periods (more risk).

By valuing the cash flow of your company you are inherently valuing EVERYTHING that your company does. If your company did something different (made different decisions or operated under a different philosophy) your cash flow would look different and the value of your business would be different. Your cash flow reflects all the decisions you make within your company. So, I challenge you with this question, if the decisions you are making don’t increase your cash flow (and buyers will pay you only for your cash flow) why are you engaging in those activities that don’t result in increased cash flow? They are not adding value to your company.

The third approach to value is the Market Approach. If you own a home or have rented an apartment, you’ve done a form of the Market Approach. When you compare and contrast similar properties and then use the comparative data to value your property, you are doing a Market Approach. In residential real estate you may compare things like price/sq.ft. or price/bedroom and price/bathroom. Once you obtain these ratios from similar properties you multiply the ratio by the square footage, the number of bathrooms, or the number of bedrooms in your home to get to a value for your property.

You can do the same thing with businesses. However, as you may have guessed, the value of your business is not driven by its square footage and its bathrooms. It is driven by other metrics such as revenue, assets, growth, leverage, turnover, liquidity, etc. Publicly traded companies and transactions involving other private industry participants provide an understanding of how price relates to the various financial metrics of these companies. Then, just like we did in valuing your property, we apply these market ratios to the metrics of your business to determine its market value.

Valuation is a complex matter with many intricacies that are not discussed here. The purpose of this article is to familiarize you with the basic valuation approaches employed. I don’t recommend that you attempt to value your business without the help of a qualified expert. But, I do encourage you to gain an understanding of these approaches so you can better focus on building value within your business before it is time to sell.

What’s My Business Worth?

Frequently, small business owners don’t stop to think about what their companies or operations are worth in value until they either get to the point of retiring and/or they have to give the business to someone else. Yet having a good perspective of what your business is worth via third party evaluation even years before the big ending, can be invaluable to helping set future direction.

A regular update of your business value in terms of fair market is critical to have in your back pocket as a business owner. Not everyone goes out in the market intending to sell their business every day, but that doesn’t stop businesses from being approached out of the blue when they are perceived as successful by bigger players. This situation is especially common in today’s tech markets. Then, of course, the question is how to respond to the offer? How about if an investor wants to get in on the action? What’s a fair value of ownership in trade for investment?

The BBC America cable channel has a wonderful show on each week named Dragon’s Den. The concept is that people who are looking for investors get a 15 minute pitch to four or five venture capitalists to sell their idea. Invariably, the VCs if they like the product offer investment for an ownership stake. The VCs have a very good idea what is a deal to them and what constitutes a waste of time. And, frequently, the people making the product pitch have no idea what their product is really worth in business terms. That’s when the VCs walk away with a 40% ownership stake for pennies. This type of poor selling is what is referred to as the down side of being in the dark, or just having just a rough idea of your business value. If you have no clue what your company is worth, you don’t have any context for making a decision.

An investor offering $1 million dollars into a growing company worth $2 million is a 50% partner. However, if the business is only worth $1.5 million then that same investor arguably gets majority control of the company just based on the numbers. That’s likely not the original intent when seeking to take on a funding partner.

On the flip side, using a company worth $1 million with no greater than 20% ownership available to an investor, only $200,000 can be targeted for growth. It might be better to take a small business loan instead and have 100% control of ownership. With no other debt, the bank would calculate a 20% loan-to-value ratio, which is very palatable to a lender.

Clearly, the above examples offer two very different strategy directions that become apparent when an accurate valuation is performed. And it’s common for many business owners going through a business valuation for the first time to go through a rough surprise versus their expectations. Much of the difference has to do with the owner’s perceived value versus what the accounting books represent. The reaction that their hard-earned work and sweat has no mathematical value is a hard pill to swallow. That’s because the energy and time involved in owning, managing, and expanding a business does not represent a usable factor in valuation. Instead, the defining factor is how much the business can produce in sales in the future.

External factors like the economy, both local and national, can sway worth projections as well. Management experience and skill are a measurable determination. The industry health the business operations in has an impact. A poor valuation may have nothing to do with the business measured internally and everything to do with outside forces.

Additionally, the frequency of valuations can have an impact on their credibility. A value-estimation should be performed when changes that impact the business occur or are expected. This can include shifts in technology, competition, the general economy/market or all of those combined.

Since business valuations are not cheap, the implementation of one should be used when it provides the most worth to the owner in terms of usable information. Otherwise, a regular valuation review every three or four years is a reasonable rule of thumb, especially in a well-established industry.

Closely held companies must have an independent valuation of their securities and assets for ensuring the successful acquisition of a business. Look for a professional corporation focused on business valuation, litigation support and valuation advisory services. You need a company with proper knowledge, experience and expertise to understand and determine the value of a company. A good company will have strong analytical and research techniques to accurately and independently determine value in today’s demanding marketplace.