Quick Backwards Valuation Methodology

There are a few ways to create a valuation when looking at a company to acquire regardless if you’re an incumbent or scaling growth company debating your first acquisition. On the other hand, as a founder, you can have your FP&A team to run this as an exercise before you approach any potential acquirers or partners. Both parties should come to the table with supplemental material as to their rationale. This post is broken into two quick sections without going in-depth: the first is a workflow & formula and the second is visual with supplemental explanations for you to dive deeper into.

A Simple Formula:

  1. Who will most likely buy the company?
    1. Is it a private organization that will utilize the cash on its balance sheet or a public company that can issue more stock to receive liquidity?
  2. What multiples are they paying?
    1. This depends on the type of multiple being utilized and is highly dependent on the maturity of the target company at play. For example, you’d use EV to EBITDA for a company with rapid growth and positive operating cash flow, incorporating profitability, or EV to EBIT for a mature model incorporating operating profit and ignoring tax differences.
  3. How much revenue does the company have at this point?
    1. i.e. for how much is it likely bought?
  4. How much money and time do I have to invest to get to this point?
    1. If you’re able to build internally, what is going to be that cost of building? Does it make better strategic sense to build vs. buy, or perhaps buy to then build on top?
  5. What multiple or IRR do I need to achieve on my money?
    1. For example, the valuation I can pay today without a strategic premium.
    2. This is a number the acquirer usually will get from their treasury/finance department. This is the hurdle rate where they must broach to not lose compared to other avenues to deploy their capital.
  6. Plus your strategic premium is based on the value extraction the acquirer will be able to achieve.
    1. This is usually at play if the company is public or has multiple bidders, but is usually a difficult number to accurately pin given the unknown future synergies that would conspire vs. theoretically.

Types Of Valuations:

There are four main facets to valuing a company. Additionally, there is the build cost and replacement cost that I will not dive into.

Above you’ll see a chart where I layout from left to right the following:

  • Market approach. Comps are usually the short-form term for comparable companies in the public sector that align with your target. You’ll identify their business as similar, review their financials, and derive some multiples ‘x’ against several facets.
  • Market approach. Precedent transactions of past acquisitions in the same space is a great tool to understand who paid what.
  • Discounted cash flow. This model will drive your internal assumptions and allow fine-tuning and sensitivity to be applied allowing you to play out multiple scenarios.
  • Venture capital approach. This is a softball viewpoint, but some deals are broadcasted with the amount raised and the valuation. Additionally, those companies may be open once mature enough with their revenue allowing someone to glean insight into private company valuations.

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