Optimising your business valuation: back to basics

In today's world, a lot of businesses are trying to push their valuation as high as possible by using different approaches. Though, as we explored in a previous article though, caution should be taken here. In this practical guide, we wanted to highlight some key areas for what is important from the side of people who value these companies - let’s get back to basics!

Generally, by default, companies are valued by 2 main methodologies. The first method is understanding the company's financial structure - checking their income statement, balance sheet, and cash flow statement, and based on that history, predicting future cash flows of the company for several years ahead, and discounting that to the present value, it's called the DCF method.

The second method is comparing the company to its peers and trying to estimate the company's value based on the market. This is called the market multiple or comparable companies method. There are many different methods of valuation that are based on different approaches, but this is the core of almost any valuation of a growth/mature company.

Let's consider factors based on this knowledge, how companies may optimise their valuation, and what aspects you should consider. These factors directly influence the DCF and market multiple methods of valuation.

Financial performance

This is the core of any business. Healthy profit margin and predictable revenue growth increase investor confidence in the company.  Recurring revenue and long-term contracts (e.g., SaaS subscriptions) are the core that pushes your valuations up and reduces uncertainty. 

Sales & Revenue

Well-organised, measured pipeline shows the people that you are getting actual performance and clear perspectives of the growth of the company. This level of operational visibility definitely strengthens the company in front of investors and on the market overall.  

Market position

Companies with clear differentiation between competitors, on average, attract higher valuations. Also, having a strong brand and a lower churn rate compared to your competitors is a strong argument for an extra premium in your company valuation. Barriers to entry to the market are also a variable in this; if higher barriers to entry, the better position of your company on the market.

Team

An experienced management team is the key, especially in the first stages of company growth. Regularly, investors value the team on the same levels as the product itself, recognising that the strong leadership in the funding team reduces the risk and increases the probability of executing the plan accordingly.

Growth potential 

The ability to scale quickly, understanding that the market size (TAM - total addressable market) and the opportunity that the company can take a part of the pie, is the great upside that you need to keep in mind.

Capital deployment strategy

A clear understanding of where the company is going is also pushing valuation. Efficient usage of capital by equity or debt, realistic forecasts, clear priorities for allocation of new capital, demonstrating maturity to investors, and their confidence in the company.

Risk management

Understanding the risks and clearly stating them also shows the maturity of the firm and its perspective to investors (e.g., regulatory risk, operational risks, and reputation risk). 

Proven product-market fit

High customer satisfaction, positive reviews, and loyalty of customer loyalty may also be an advantage in valuation, especially if any other parameter of these systems is underperforming.

Something we feel it pertinent to highlight here is where IP is concerned, businesses can often overinflate IP values as they’re intangible. The best way to validate this is by validating product-market fit, this substantiates your IP  and will bolster the overall business valuation. 

Transparency

Clear records and easy-to-understand KPIs. Ideally, businesses should be able to show that their house is in order. 

Conclusion

We can see here that a lot of components really matter. But the point we would like to highlight is that it's almost impossible to have everything right, but if, for example, you cannot improve one factor, you can focus on another one, which will overperform, which would be the argument why the company has advantages overall. You should understand where you have unique value and try to focus on that which would differentiate you from the competition. Valuation is the balance of strengths and weaknesses; you don't need to pretend that you are the best in everything.