According to business valuation expert and author Dave Bookbinder, the simple question, “what is my business worth?”, is consistently one of the most frequent questions people like him get asked.
The answer can depend on a variety of factors and traditionally businesses follow three methods for determining valuation. Yet some metrics, like employee engagement, can be overlooked and others, like global economics, can take on outsized importance.
Currently, the global economy has never been more influential over company valuations than it is today, and there’s a lesson in that, Bookbinder said during a recent Oracle NetSuite Business Forward session.
“The best plans that everyone made before COVID went right into the hopper,” he said. “You can do all the great planning in the world, but the future is uncertain.”
Even so, many companies continue to generate and hold value despite the challenging environment and could potentially command a premium in a merger or acquisition. The key is not to cut corners when determining that value.
Choosing the Right Business Valuation Method
Bookbinder said that too often, companies are swayed by what he refers to as the “back of the envelope” and “back of the napkin” methods, which really aren’t methods at all. They generally result in overvaluing a company by not looking closely enough at all the elements that potentially affect value.
Factors such as milestones, the state of the micro-economy within that company’s industry, management depth, competition, intellectual property and customer mix can all influence a company’s value in ways that may not be immediately apparent.
Bookbinder said there are essentially three types of valuation methods that take all of this into account. The asset approach, which focuses on a company’s net assets, makes sense mostly for companies with significant assets, such as real estate holdings, or for those that are struggling. Meanwhile, the market-based approach is similar to how homes are priced, with numerous indicators being used to create a list of “comps” — or companies that provide good apples-to-apples value comparisons.
Then there’s the most reliable method: the income approach, which is based on predicted future performance. It relies on projected revenue and expenses, expected investment returns and anticipated cash flow.
The thinking behind this method is this: In general, if the perception of risk is greater, then investors want to be assured of higher returns, which means decreased value. As the perception of risk is reduced, valuation increases, meaning convincing financial forecasts can go a long way to bringing greater value.
Of course, when making predictions, that whole uncertainty thing raises its head again.
“Crystal balls are cloudy,” said Bookbinder.
Putting People First
What can really tip things in a company’s favor, he said, are the intangibles, things like brand, customer relationships, intellectual property and technology. And there is one intangible that rises above all others as a factor that determines value: People.
Bookbinder, the author of “The New ROI: Return on Individuals,” which explores the benefits that investing in a company’s workforce brings, has his own views on this. For instance, he said that just one-third of employees globally are “engaged” with their jobs.
“Imagine if your business is a lifeboat,” he said. “You’ve got three employees in front rowing, four in the middle observing, and three actively trying to sink you. Just imagine if you could turn the knob on employee engagement?”
Bookbinder argued that engaged workers are more productive, and thus drive value. Engaged workers, he said, will go above and beyond to improve cashflow, tapping camaraderie to drive not just productivity, but also innovation and morale. As a result, companies that actively invest in their people typically out-perform the market, while those that don’t saddle themselves with disengaged employees and disproportionate staff turnover.
“I always say, the value of a business is a function of how well the financial capital and intellectual capital are managed by the human capital,” he said. “So you’d better get the human capital part right.”
In other words, companies should be intentional in establishing their corporate culture, and that means a lot more than putting a ping-pong table in the break room. That means giving them the tools they need, providing opportunities for advancement and surrounding them with other great people.
It’s All About the Future
But if there’s one thing Bookbinder wanted people to take away from his talk, it was that the best valuation processes focus on the future. Whether that means engineering an income-based valuation approach based on data-driven predictions or hiring an M&A advisor who will push to create a sense of urgency around the company’s future fortunes, no one really cares what a company did last week, or month, or year.
“Valuation is a forward looking exercise,” said Bookbinder. “History is great, but what are you going to do for me tomorrow? That’s what investors want to know.”
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