Quick and Dirty Business Valuation

In my last post, I accosted general partners (GPs) for sugar-coating business valuations. So, to ensure constructiveness, I thought I’d give you my perspective on how a business valuation should be conducted in these crazy times. Of course a multiples valuation consists of just earnings and a multiple, but due to recent volatility, there are a couple of important considerations.

These considerations are based on using a fair and likely maintainable earnings figure and using a fair and reasonable market multiple. My method for coming to the earnings figure is to extrapolate the most recent performance using historic seasonality.

Understand the monthly seasonality of the earnings – by knowing seasonality of the earnings, we’ll be able to extrapolate a maintainable earnings figure from the most recent actual data. Normally we’d just apply a growth rate to last year’s earnings, but due to high volatility, I only want to use the most recent data to determine maintainable earnings.
Find the last three months of performance data – let’s focus on EBIT as a proxy for maintainable earnings since it’s probably most representative of maintainable cash flow (FCF). I say this because recent actual FCF may be higher than maintainable FCF because most businesses have put the brakes on capex and other things that affect FCF. If expectations are that maintainable earnings will fall even further, don’t ignore it, make the required and fair adjustments for the business valuation.
Extrapolate the three month data using seasonality estimates – for example, if our three months worth of earnings data (say March, April and May) has historically accounted for 30% of total earnings, let’s extrapolate that out to a full year. So if the three months of EBIT is $7m and we suspect it will represent 30% of the full year, divide $7m by 0.3 to get about $23m for the forecast of maintainable earnings. Again, make any fair adjustments.
Glance over similar listed businesses to choose a multiple – forget recent transactions (unless they’re very recent and in the same industry and of similar size). Don’t get cute with overly geared listed companies with $0.01 share prices trading at multiples of 200x. Also, don’t over-do the conservatism with companies teetering on the edge of bankruptcy and trading at multiples of 1.5x. Ask yourself, what business valuation multiple would I pay for this business right NOW. If it’s over 5x or 6x EBIT, then chances are you need to get a grip.
Calculate the enterprise value - multiply the earnings from 3) by the multiple from 4). This should give a relatively fair EV if the earnings and multiples were themselves fair and conservative. So say we had $23m in maintainable earnings and a multiple of 5x, then our EV is $115m.
Adjust to get your equity value – in simple cases, take EV, subtract debt and add back cash. If we say our net debt in our example is $30, then $115m – $30m = $85m. From that total equity value, multiply your percentage share to get the value of your specific equity. So say we own 60% of the company, our equity value is $51m, which is the business valuation.

There you have it, a quick and dirty, yet conservative, multiples business valuation for crazy crazy times.