Value creation is arguably the single most important initiative for any company. Yet executives are not always as focused on it as they should be. With all of their other responsibilities, they set value creation aside and assume they’ll get there by growing revenue and improving earnings.
Unfortunately, even healthy growth in revenues and earnings does not necessarily create value. There are many other factors at work. How does your company rank among competitors? Is your industry growing, stagnating, or in decline? Do you own intellectual property? Answers to these and other questions about your company’s underlying value drivers get you closer to where you need to be in actually determining your value.
We believe CFOs should think of themselves as chief value creation officers. Since they already oversee the company’s annual budget and strategic plan, they have the skills and resources to direct this initiative, and a regular, detailed examination of the company’s value will in turn strengthen both the budget and strategic plan.
The best way to measure value creation is to produce a valuation once a year. Most CFOs have some experience with traditional valuations. These are typically prepared for specific situations, such as buying out an investor or borrowing funds. The key to traditional valuations is that the work needs to be accepted by the two parties for whom the valuation is being prepared. That requires using an impartial, third-party appraiser.
However, traditional valuations are expensive, time-consuming, and complicated. Most midsize companies avoid them unless absolutely necessary. We believe that’s a mistake. The risk of not knowing your value is far too great and can have unforeseen consequences. In working with hundreds of such companies over the years, Phillips has seen too many that poured resources into declining business areas, failed to exploit new opportunities, or agreed too quickly to an inferior buyout offer, all because they had no idea of their true value when they needed it most.
We have created a valuation tool enabling a company’s internal teams to conduct regular valuations themselves, without the expense and distraction of a third-party appraiser. Our methodology, QuickValue, involves a careful identification and rating of the eight to 12 value drivers that best define your business. In our next article, we’ll take a deeper dive into value drivers and describe the process by which you can arrive at your company’s value driver score (Hint: it’s not just about what you do well; a successful and useful valuation also means being objective and honest about the vital areas where your company is struggling).
Once you know your value driver score, the next step is determining your multiple ranges. Your team will examine multiples of either EBITDA or revenue from 15 public companies in your industry that are the most similar to your company (we’ll explain why in our multiples article). Then you determine the range in which your value is and, if necessary, make adjustments for private company M&A transactions.
With your value driver score and your multiples range decided, you are ready to zero in on your value. Here’s a hypothetical example.
Company X has a value driver score of 30% (out of 100%). This is low, with plenty of room for improvement. Company X determined its EBITDA range is between 10x and 20x. When the value driver score is applied to this range, the EBITDA multiple was determined to be 13x, as shown below.
Knowing that their EBITDA is $20 million, simply multiply that amount by 13x. Company X is worth $260 million.
With a valuation in hand you, as CFO (and chief value creation officer) now have critically important information needed for future decision-making. You have established a baseline with which to compare next year’s valuation and to measure your efforts in value creation.
Reed Phillips is CEO of mid-market M&A firm Oaklins DeSilva & Phillips, and Charles Slack is a business and financial writer. They are the co-authors of the book, QuickValue: Discover Your Value and Empower Your Business in Three Easy Steps.
This is the first article in a six-part series about how CFOs can lead an internal team in determining their company’s value.
- Part 1: Are You Your Company’s Chief Value Creation Officer?
- Part 2: How Well do You Understand Your Company’s Value Drivers?
- Part 3: Finding the Multiples that Best Express your Company’s Value
- Part 4: Unlocking New Value for Your Company
- Part 5: Putting Value at the Center of Your Strategic Planning
- Part 6: A Q&A with Reed Phillips and Charles Slack