Our Approach to Assessing Value

“What’s My Business Worth,” The Often Premature Question:
Most entrepreneurs we meet with, after the appropriate initial pleasantries, typically want to ‘cut to the chase’ and ask “so, what is my business worth?” At this early point, it is important to note that we are typically in possession of very little real information on which to form an investment grade view about the business – critical context which will meaningfully impact the value we perceive.

Framing the Transparent Process: Rather than prematurely set stakes in the ground without the necessary context, we instead engage the entrepreneur in describing the process of ‘how’ we go about becoming knowledgeable enough to give a serious view on value:

  1. Fundamentally Strong Business: Our approach gauges whether a company is actually a rare business that has inherent stability (consistent historical profits on an adjusted basis and strong returns on capital, entrenched position with attractive and diverse customers in non-cyclical end markets), is unique in its competitive advantage, business model and ability to innovate, while also offering growth potential through operational enhancement, organic expansion and follow-on acquisitions.
  2. Good People: We focus extensively on understanding the entrepreneur and their team in terms of their character, commitment to hard work, self-motivation and our ability to trust them. Actions speak louder than words in this regard, so we typically rely upon how people have lived their lives and independently-sourced references of their character. The continuity of good people with the business, particularly when the situation presents ‘key-man’ risk in respect of customer relationships and operational execution, makes this assessment of critical importance.
  3. Good Deal Dynamics: Positive dynamics that create strong alignment – such as the entrepreneur and management participating with their own funds (either by way of roll-over or with fresh capital) and recognition that the transaction is fundamentally an investment in the team to execute the business plan – are critical to a successful deal. Other factors include the ability to attract bank financing and the presence of performance-based price mechanisms that deliver additional value to the sellers over a multi-year horizon (‘earnout’ is a colloquial term, as these may be based on future revenues as often as they are on profits).

balanced_valueSumming it All Up (or, Boiling it All Down): After much good discussion with the entrepreneur and review of these key factors, we will then be in a position to translate all of that context into an investment grade view on the value we would offer for 100% of the business enterprise and the composition of that value between cash, shares and or performance-based price.

So what does this mean in terms of generalities? For a Canadian business producing between $2MM to $4MM in adjusted EBITDA – which has good people, which possesses many of the characteristics of a fundamentally strong business and which has positive deal dynamics – is most likely going to be worth, to Carpedia Capital, a value of 4X to 6X adjusted EBITDA. As most businesses will have some, but not all of these characteristics or will exhibit exaggerated critical risk factors, they may fall between the 4X and 5X range whereas those rare businesses which have most or all of these characteristics with no exaggerated critical risk factors will fall between 5X and 6X. Where a business has too few of the essential criteria we seek, we merely decline to pursue the transaction rather than express an artificially low view of value. In respect of larger businesses, such as those producing more than $5MM of EBITDA, an escalating size premium will often come on top of the above noted ranges.

Common Mis-Estimations, Made By Entrepreneurs, Regarding Business Risks & Value: This brings us back to the entrepreneur that wants to know the value of their business. We’ve met only a few entrepreneurs that already knew how certain critical risk factors would interplay with the value that a third party would perceive in their business – meaning that most entrepreneurs misperceive the value of their business to be higher, for a variety of reasons (ranging from anecdotes about what other people may have sold their businesses for in the past to visceral emotional attachment to a desire to merely end up with a certain dollar amount of money), than what an informed third-party would perceive. However, what most entrepreneurs often fail to account for is their closeness to the proverbial ‘trees’ causes them to blindly underestimate the risk a third party perceives to the overall business ‘forest’ from critical risk factors such as customer concentration, cyclicality and key man responsibility; higher risk ends up being reflected in a price that appears lower relative only to inappropriate expectations that ignored such risks. Our transparent and consistent approach seeks to address these issues upfront, so as to avoid any unforeseen differences in opinion regarding total value or the composition of value amongst cash, shares or performance-based price.

Often, without recent experience weighing upon them from these risk factors, only the weight of time and or a reduction in profitability stemming from one of these usually binary risks moving against them will bring the entrepreneur to the table. That is, unless, you offer a price that ignores the risk factors – of which the surest sign of this ‘winners curse’ is an entrepreneur running to embrace your offer with little pause or sign of uncertainty.

Conclusion: Most entrepreneurs try to ask for your conclusion on value before you have the necessary context required to put forth a bona fide view of value. While we do clearly discuss process upfront, we typically defer setting any stakes in the ground until a clear understanding of the business’ context is obtained. We always look for certain attributes in the businesses we evaluate – such as a fundamentally strong business, good people and good deal dynamics – and those which meet our requirements are ultimately presented with a fair value offer derived in a manner consistent with our process. Transparency and consistency has been our best approach to avoid late-in-the-game differences in opinion or surprises regarding value and have proven to be the most effective means to reach a fair value deal that will successfully transact.

This manner of transparency is even more essential when the entrepreneur is not only deciding if they should sell you their business, but also simultaneously evaluating whether you are someone with whom they want to partner in further building their business; the tone and approach you set upfront must carry through the entire relationship consistently.

What’s Next: Picking a financial partner versus picking the right financial partner.

We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to capital@carpediacapital.com or contact us.