Although there are many methodologies to value small and
mid-sized companies, it usually comes down to two: the market approach (looking
at comparables) and the income approach (discounted future cash flows).
We (Compass Point Capital) use both methodologies depending
on the situation, but I’ve found and enjoy using a piece of software that
employs a unique version of the income approach.
BusinessValueXpress (BVX) is one-of-a-kind business
valuation software that simplifies business valuation and provides objective
valuations that equal real-life actual transaction. BVX integrates Price, Terms
and Deal Structure, and uses optimization techniques to satisfy the needs of
all parties to an M&A transaction.
Like many pieces of software, the “garbage in, garbage out”
rule applies. You first have to
carefully analyze a company’s financials to determine the level of earnings,
and an estimate of future earnings. You
then enter this information into the BVX model, including balance sheet
information such as accounts receivables (so it can estimate working capital
needs) and assets (so it can estimate what kind of financing might be available).
You then set up various constraints in BVX. For example, you can enter the following
items into the BVX model:
has X amount of cash
requires 35% return on their invested equity (ROE)
will carry back X amount
- An SBA
lender will lend X amount at Y terms
- A bank
will provide a working capital line based on AR
You then run the BVX model, and it will calculate the
maximum selling price which provides the ROE to the buyer and also prevents him
from going cash negative. It does this
iteratively. In other words, with so
many variables it would be impossible to actually solve the equation. So BVX
takes a guess at a selling price, then checks to see if any of the constraints
were violated. It then guesses again and
again until it either reaches a solution or finally gives up (it does
occasionally say that there is no solution after many thousands of iterations).
The greatest benefit to BVX is the ability to change things
quickly and see the impact. What if the
buyer put down more money? What if the
seller’s note was extended to 10 years?
How about a balloon payment? What
about an earnout (performance-based payment to the seller after the
close)? Its all there, and much more.
The software is very deep, and sometimes I have to back up
and simplify, under my rule that simple is usually better.
I’ve used it once to calm down an angry buyer that didn’t
believe our valuation that was based on the market approach. We had done the valuation for a business
brokerage firm as a third party valuation, and a prospective buyer was really
having trouble with it. I plugged the
information into BVX and let it rip. The
result was very close to our original number, and the buyer at that point (after
I explained how BVX worked) had little to argue about. He actually called up the business brokerage
firm and apologized.