“Indeed, the single most powerful pattern I have noticed is that successful people find value in unexpected places, and they do this by thinking about business from first principles instead of formulas.”
Peter Thiel (founder of PayPal)
Zero to One: Notes on Startups, or How to Build the Future. 2.
Talley Capital Group specializes in finding and creating value where others don’t recognize value exists. Whether your company is large, small, profitable or unprofitable, our value analysis process can be a great first step to unlocking hidden value. Even large, growing, profitable companies can be struggling in the minds of their owners who may see storm clouds ahead. Some of the companies that we work with are small from a revenue perspective, others are in decline. Sometimes they are in financial distress. Difficult circumstances alone do not mean that a business lacks value.
Why the Industry Multiple Formula May Not Be a Good Fit For Your Business
One of the most common formulaic concepts used by professionals involved in mergers and acquisitions is the “industry multiple” concept. You can only arrive at this value by averaging the outcomes of many different transactions. For example, distribution companies in the same industry might sell for anywhere between 2X and 10X and yet the industry multiple might be 4X. What a business owner needs to understand is whether their unique business is a 2X business or a 10X business. If the business is a 2X business, marketing it with the expectation of a 4X outcome will only lead to disappointment and wasted effort. If the business is a 10X business, marketing it with the expectation of 4X will result in a sale; but, almost certainly for less value than the owner should have realized.
Assessing the value of and marketing a business based on “industry multiple” expectations almost always leads to less than optimal results for the business owner.
Our value analysis process starts by considering the financial performance of the company and includes an assessment of other business transactions. This is the easy part; the hard part is identifying the unique value drivers that created the historical value reflected in the financial statements and will sustain the future value of the business. Unique value drivers are the first principles for which a buyer is willing to pay. They are sometimes hard to identify because they are the result of a complex combination of people, product and process. Other times, they can go unrecognized or unleveraged even though they are hidden in plain sight. When this happens selling on the basis of an industry multiple and historical financial performance will almost certainly look like a bargain to the acquirer. The financial performance shown in the income statement and balance sheet are merely a reflection of the true source of value. They are not THE VALUE.
Why We Focus on The Substance of a Business Instead of Defensible Valuations
Many of mergers and acquisition practitioners rely upon “defensible valuations” based on accepted formulaic methods. When it comes to this type of thinking, we find another commentary by Peter Thiel worth quoting:
“At Founders Fund, we focus on five to seven companies in a fund, each of which we think could become a multibillion-dollar business based on its unique fundamentals. Whenever you shift from the substance of a business to the financial question of whether or not it fits into a diversified hedging strategy [i.e. “defensible valuations”] , . . . investing starts to look a lot like buying lottery tickets. And once you think that you’re playing the lottery, you’ve already psychologically prepared to lose.”
Peter Thiel (founder of PayPal)
Zero to One: Notes on Startups, or How to Build the Future. 87.
We stand apart because we focus on understanding the story or finding the unrealized opportunities that will entice investment in the future of a company [i.e. “the substance of a business”]. This applies when we are helping an owner improve operations, prepare for an eventual sale and when we are marketing a company to prospective buyers.
Circumstances where a Value Analysis may be useful:
- Intergenerational transfer planning
- Identifying opportunities for operational improvements
- Confirming value immediately prior to marketing a business for sale
- Benchmarking current value as part of planning an exit in the future
- Independent, objective third-party assessment when there is a dispute about value
