• Leverage—you fix up the house and the neighbourhood rises
in value. This is the “Buy, add value while paying down the
debt and sell” method.
• Multiple arbitrage—you buy by borrowing other people’s
money. You develop the house as well as wait for the value
of the neighbourhood to rise. This is the “Buy, arbitrage and
Growth is when the fund pays 5 times the earnings and a
few years down the road, sells at 7 times earnings and they are
happy with that as they have made some money. The fund may
pay 7 times earnings, knowing that there is the ability to grow the
company at 10% over the next 4 years. Would you be satisfied if
you buy a house, live in it for five years, pay the bills and value of
the neighbourhood goes up by 10%? It does give you a reliably
One CEO irritated by the use of EBITDA (earnings before
interest, tax, depreciation, and amortization—see glossary)
declared his company to be worth a multiple of 13 times, thus
assuming that he can grow his company at 23% a year. That is
how valuation works—future earnings potential of the company.
If you bring in partners and are confident that you can grow
your business at 23% per year over the next 5 years, by all
means expect such a steep multiple. Otherwise—now that you
understand how debt is used as one of the key value levers much
like buying a house—you can see how funds would be challenged
to see future profits.
The valuation methods used depends on your company’s
stage of development.
For example, seed and
early stage companies
are valued upon the
basis of how much
hard capital you have injected into the business. Factors such
as intellectual value, so-called ‘sweat equity’ and opportunity
cost, come into play. Previous successful involvement in a private
equity supported venture will enhance your appeal to the investor.
Companies at the expansion stage will be valued differently.
Investors may base their valuation on comparable company
multiples of sales. Further down the spectrum late stage
companies will most likely be valued on the basis of comparable
earnings multiples. At the end of the day the key factor that the
investor will focus on is predictable future growth and from that,
predictable future earnings.
Company valuations may differ from industry to industry.
Various valuation methods are highlighted in the table below but
the details of each of these are beyond the scope of this article:
To give you a quick idea, here is a quick break down of two
more popular valuation measures used which are:
• Multiple of EBITDA and
• Discounted cash flow (DCF)
has become not only
a tremendous engine
of growth but also a
critically important style
of managing. I think we
need people with that kind
of courage and vision, and
they need those of you who
have capital to invest.”
Harvard Business School Dean, Kim B. Clark
Try not to overestimate the
value of your business