11th March, 2020
By Julius Masaba
February was quite a busy month but am back.
I value life. But a lot of things happened in those twenty-nine days. Some good some bad.
I will start with the bad news. It was a gloomy month for me and some people I know.
We lost a family soul, a wise man from the East named Douglas Musunga, a photo-preneur of his own class. Most of you around Kampala must have known him. I liked to call him ‘Uncle Douggie’. If not, you must have heard or known about his award winning photo works for the 2018 UPPAs.
Again, we lost another distant young gentleman towards the end of the same month, a namesake of Uncle Douggie! Terrible beginning of 2020. Anyway, the good die young, they say. Let’s pray for God’s protection over our lives.
But the devil was not done yet, he gruesomely took another young, intelligent chap from us (I and my classmates) by the names Francis Ssemaganda, in a motor accident. He was working with African Development Bank, very friendly family guy.
May their souls rest in eternal peace!
Again, I value life. I felt the need for a moment of silence for myself before punching in all these characters you’re reading though it’s not the most important part of this article – it’s just to tell you how we need to take life seriously, live your dreams, do good, inspire others.
Now, the good news is that it was the ‘love month’ because of the valentine day mood 24/7 (at least for some people I know) and those who were treated to dates, flowers and anything red enjoyed themselves, at least from what was happening around me.
But the good news for me was that I managed to undertake a thousand dollar business valuation engagement for one of my SME clients, a start-up in the agro-processing sector domiciled here in Uganda. I have been with the firm as a financial/accounting and business advisor or consultant
These kinds of assignments don’t often happen, but I was priviledged to have one this year. You see, business valuations don’t just happen anyhow. There is usually a cause, a need, a purpose. Otherwise, one would just want to know the value of his/her business by just looking at the balance sheet at the end of the period.
However it would not be enough or conclusive, say, to someone who wants to bring on an investor, venture capital firm, an angel or presenting an employee with share options in the business. It would also not be the same value to an acquiring corporation (during mergers & acquisitions), or even during sale of the business.
It would also not be the save value when the aim is to go public – offer shares to people or list on the local securities exchange.
For many entrepreneurs locally and globally, looking for financing and most especially investors, to inject money into your young and not-yet-grown enterprises is one of the priorities. However, there is need to also know what your business is worth, or its value.
Personally, I had always wondered how startups or big businesses come to know their value or how newly listed companies get to determine their share price – something which you will follow (I mean accepting the price) even without taking time to question the status quo.
Well, personally the reasons could be any or all of these;
- It’s hard and almost impossible to go to the listed company’s office asking how they came up with the share price. In fact, it’s unfathomable.
- The people buying shares or investing in that business or company are just not inquisitive.
- The public or prospective shareholders have no time for looking at complex numbers, and or they have a private financial advisor doing that for them.
- Band wagon effect.
I know we all fall under either 1, 2, 3 or all the above, but It’s understandable.
So, how did I do it, I mean the valuation?
First, allow me to tell you that it was not rocket since.
Secondly, I happened to get curious on how businesses know their value. Because almost half of 2019, this very client of mine was always having issues with separating assets. He didn’t know what asset was his and what was for the company. He ended up inflating the business’ value or undervaluing it. The most basic information that was always helpful was the balance sheet figure.
Some answers remained unanswered each time I asked him what the worth of his business was. But at least he had an idea – it was close to USD540,541 (UGX2Bn), at least from his judgement. I could not argue with him further because he had reasons why, but with my accounting and financial background and striving to be objective and evidence based, I told him the worth of his business is in the balance sheet.
You should remember that one quality of any consultant is the hunger for knowledge, curiosity, love for discovery and utmost skill of self-teaching and do your own self-study. It keeps you a notch higher in the game and at least a class apart from the rest. You can never get all knowledge from the class room and you also acquire knowledge at your own pace – professionals invest in themselves.
So, with the numerous questions in my head on business valuations and concerned with the client’s question of ‘what is the value of your business’, I went ahead and looked for an online crash course on financial modelling and business valuation by the Corporate Finance Institute (CFI). I read the material and also attempted online questions, tests on what I was reading.
I already had some knowledge on financial modelling and thus some parts were easy. The business valuation bit was the only new part, but with the help of forecasting/projecting experience I knew it would soften. Now the good part is that no sooner had I read most of the valuation bit than my client called.
Client: Hullo Julius, can we meet today after 5pm? We needed to talk.
Me: Yes, talk to me. Any problem?
Client: Yes, a big problem. We need to value the business. The investment club guys want to know its value and they have given me deadline as next Wednesday (he called on a Thursday).
Me: Okay, let’s meet tomorrow evening (a Friday) and we shall see what to do.
Client: Alright, thank you so much for your time (hangs up).
He sounded like a client in distress, of course they always are. Always getting stuck on what to do regarding certain things in business, and that’s when we come in to calm them down and tell them everything will be alright.
At the same time, it’s an opportunity. And the more you stay with a client, the more the opportunities. It could be getting more work from them or referring their friends or other people to you. That is why client relationship management is key in any service industry. A bad relationship can give you bad PR.
So having scheduled the meeting, we met and he took me through the whole issue. The investment club (in this case the investor) to which he belongs to, had asked for the value of his company, before they sip coffee with him.
However, I told him that you need to know the value, the number of shares available as well as the share price; so it won’t be easy.
After agreeing on the scope, came the fees negotiation bit – always one hell of a moment. I will not talk more on that, it might change the mood of this article.
Anyway, I told him the work would take a fortnight and maximum three, if he wanted good work. Two, if he is going to provide all information at ago, with my additional research and embark on the dirty work with sleepless nights. Note that, data is among the biggest assets of any business.
Without data, you may not do anything.
The valuation assignment kicked off well, though with a few back and forth instances asking for this and that, confirming truthfulness of figures, etc. Another thing with retaining customers is that you end up not asking for too much data all the time, you have a folder about the business already.
The valuation process just uses formulas after getting the approach to be used or applied. If you are well conversant with financial statements, cash flows financial management, forecasts/projections, etc., then you are ready to go. A little knowledge on corporate finance will be a plus. I told you about the online crash course by the CFI.
Note that valuations are done using three (3) common approaches, and these are;
- The Asset-based approach
- The Income-based approach
- The market-based approach
The asset-based approach is done by valuing the tangible assets (PPE) of the business after deducting depreciation cost for the respective period. The reason it’s also concerned with replacement cost. This is good if the business has been in existence for a very long time, common in manufacturing, etc.
The income-based approach applies revenues or income, cash flows. It puts into consideration the future and the present cash positions of the business through discounted cash flows. This is where terms like Net Present Value (NPV), Future Value (FV), Terminal Value (TV), etc. come in. It’s quite good for businesses with a few years of revenue and most startups tend to use it, much as they’re usually in the pre-revenue stages. You do projections of at least 3 to 5 years.
The market-based approach uses comparatives in the industry or market. You benchmark your business basing on what other players in the market are valued at. For instance, if you have an electric car making startup, you will need to use financial figures in the industry from competitors and those listed on the securities exchange (if any). It uses a lot of ratios, very complex stuff.
Note that it’s good to use all the three approaches in valuation and then come up with an average final value. However, sometimes it maybe be time consuming. In cases where you have no sufficient data, especially for the last approach, you can use the second one. For the case of my client, I used the income-based approach since we had enough information to work with.
So how did I value the client’s business?
Remember, you need to have information on; past/historic financial statements or reports, budgets, human resource aspects, business plan (but optional), etc.
You then do forecasting basing on the historic financial statements – balance sheet, income statement, cash flow statement, depreciation schedule, etc. This will help you establish the positions for unlevered, levered cashflows. In all this, the income statement plays the most pivotal role.
So, I think you understand why it’s not rocket science, even a business degree finalist can do it. The bit of financial management involving NPVs, FVs, TVs, equity valuation, share price estimation is the somewhat complex but short process since formulas are available.
Once you establish the two important cash flows – unlevered (UFCF), the earnings before interest, tax, depreciation and amortization (EBITDA), get the levered (FCF), NPV from the forecasts, sum of the NPV of the forecasts, TV and the NPV of the TV. Most critical figures are the discounting rate, which can be obtained from the industry, the EV/EBITDA ratio – which is a factor, say 40x.
Applying the formula: “a/(1+b)^t” on total cashflow in final year and the terminal value in the same year gives you the NPV of Forecasts and NPV of TV. Remember the TV is got in the final year. To get it, you also need to apply the EV/EBITDA ratio (sometimes denoted by, say 40x) on the EBITDA.
Total Enterprise Value (TEV) is got by adding the market capitalization to the interest-bearing debt and the preferred stock and then deducting any excess cash. However, it could be a long way for some people especially since you need to get market capitalization, which is based on market, industry averages, performance stats of listed companies, etc.; most applicable in the West but not the developing countries.
The other way is to get the TEV also called Enterprise Value (EV) from the TV. But this involves computing UFCFs forecasted over a certain number of years and getting the PV at end of the years using a discounting rate, say 10%. This is the option I used for the client. Local market capitalization statistics are scanty or almost unavailable in Uganda.
You also need to know the initial equity holding of the company, number of shares and at what price per share, percentage of each co-founder’s shareholding, etc. In other cases, companies have an equity pool left for future investors, call them unallotted shares.
However, if you had all shares distributed fully to give 100%, then you will need to visit Uganda Registry Services Bureau to change the shareholding due to entry of a new shareholder or investor. You also need to establish how much the investor wants to bring on board. Make sure the shareholding being given up is between 25% and 35% as per the ideal market practice, depending.
Knowing the value of your business would also allow you to know how much equity to give out to your employees, angels/angel investors and of course venture capitalists (VCs). It also helps you establish the sale price of your business if you’re a serial entrepreneur, and during mergers & acquisitions.
With knowledge of the value of your startup or business, you have an advantage when negotiating with any investor when you meet them for board room discussions. When they start mentioning things like “Price is what you pay, value is what you get”, be ready to agree or disagree.
Valuations outside Uganda are common when done by serial entrepreneurs – entrepreneurs who create startups or businesses for sale or buying and selling. In Uganda, it’s quite hard to find entrepreneurs creating something from witty ideas and selling it off. Reason being some of the formalities are too much.
Also, some business owners don’t want to relinquish their businesses to other people, they prefer holding their majority shareholding – even after bringing an investor on board as shareholder. Plus, I once overheard someone say, “Ugandan startups are uninvestible”. Another Twitter icon said “Ugandan startups are not investor-ready”
Well, perhaps true perhaps not.
But what I can say is, just start and grow your startup or business organically. The right time for valuation will come. Like the wise King Solomon wrote, “Everything has its own time”.
NB: This article first appeared on Medium, by the same author. Click here
About the Writer
Julius Masaba is a private investment researcher and business consultant. He also works with Ablestate, https://www.ablestate.org/ and a WordPress writer/blogger on startups, entrepreneurship, business and finance. He loves tech.