Normally company receives equity financing in several rounds in order to motivate management and decrease the underlying investment risks.

If a company is worth 60 units (pre-money valuation) and an investor makes the investment of 20 units, the new, post-money valuation of the company amounts to 80 units. The ownership share gained in exchange for a new investment thus amounts to 25%.

In case of start-ups, the value estimation is due to high risk somehow vaguer. Therefore angel investors and venture capitals often offer certain investment amount for a particular ownership share based on their experiences and insights. Let’s say 25% for the investment of 20 units. However, by doing so, they have implicitly set the post-money valuation of the company to 80 units and pre-money valuation to 60 units.

This basic example illustrates the general concept. However, in reality the calculation of post-money valuation is more complicated due to convertible loans, in-the-money warrants and in-the-money employee stock option plans (ESOP).

In fact, the pre-money and post-money valuation should derive from the calculation of price per share multiplied by the total number of shares. Therefore, one has to consider the number of shares on a fully diluted and fully converted basis.

If the value per share increases compared to the previous round, then the investment is called an upround. It eventually means that the pre-money valuation is higher than the post-money valuation of the previous round. For the vice-versa case industry practitioners use a term downround.

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The owners of a privately-held engineering company engaging in medium-size utility projects approached us in panic to organize the sales process and find a solution to provide the sufficient liquidity until the new owner steps in. The company was performing extremely poor recently and felt into serious liquidity problems. Revenues collapsed and levels of financial debt rose in three quarters of a year from sound indeptedness to 180% D/E and 10,3x Debt/EBITDA. Owners were 100% sure that the company is on the way to bankruptcy and were only expecting a small fee for it.

According to their opinion, potential buyers could be managers, currently leading the company.

Addressing the pain: Company worth in the context of value generation

Consilue approached the valuation in line with the top-down approach, which also included in-depth analysis of the industry. After careful examination, we figured out that the demand for projects is highly correlated with cofinancing activity of EU structural funds and the valuation date matched the transition between the two investment cycles. Furthermore, the size of the EU contribution for the next investment cycle was also significantly changed for the key markets the client used to serve in the past.

After understanding the reasons which pushed the client into liquidity issues, we performed the in-depth financial analysis. We broke-down business into individual projects and analyze and project the developments one by one. We figured out that the company is in fact expecting a good profitability in the following two years, they only need to re-focus their activity on more prosperous countries in the region. Furthermore, also a significant increase in the cash conversion cycle (mainly increase in accruals) already indicates better times and is in fact by its nature only temporary.

For decision-making purposes, we decided to simulate the generation of economic value by years with and without operational restructuring and improvement in profitability. The purpose was to show the shareholders the importance of the active involvement into the future business activities of the company.

Later on we performed also the corporate valuation based on going concern. Since we used market value as our base value, also successful operational restructuring was assumed.

Results: Company worth estimate done right

We have showed the shareholders that the market value on the date of valuation is in fact significantly above their expectations. They understood that they were played by managers to sell them the company for the cheapest possible price.

Despite the existing high levels of debts, we persuaded banks to support the company with the short-term liquidity injection and stand aside.

Client’s testimonial:

When estimating the value of the company we took the EBITDA and multiply it with a given multiple. That was so wrong and almost costed us millions. One truly needs to understand where the value comes from. In our case, it was generated from the change in net working capital (decreasing the accruals) in the first year and strong EBITDA in the first two years.

We are sincerely thankful to Consilue for showing us the right path. Now we are about to change the management and actively approach the operational restructuring.

Advisor’s thought:

Valuing a company requires a deep understanding of the business. Often the process reflects many interests and fast response – as in given case – which makes it challenging.

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Business valuE determinants

Business value is affected by cash flows from operations, changes in net working capital, net investments, growth potential and underlying risks. Any measures improving these determinants will influence the business value.

However, not everything is in the power of companies to influence. Business worth is significantly impacted by macro factors. In this context one should understand the importance of economic climate as well as industry developments and trends. This is why timing to M&A is very important.

Hint: As consultants we often prefer to present the client the value development cycle. Business valuations in various points in time is a good reference point for them to see if they are confident with the business value at a particular time.

Prioritizing the measures – doing the right things counts

The more value the company adds to the supply chain, the more important player it is and higher its business value. For that reason, it is important to understand first the needs and requirements of key stakeholders and ways to meet them effectively and efficiently. Based on that fact, one should then be prioritizing the recommendations shared below … 

Tips & tricks for higher business valuE

Step 1 to higher business value: Ensure high cash flows from operations

– Differentiate your business
– Brand your product
– Tie your clients to your products/services
– Focus on most profitable products and/or services
– Acquire the right sales & marketing techniques and grow your revenue
– Appreciate and retain your key employees
– Establish barriers to enter the market
– Gain bargaining power against other companies in the supply chain
– Exploit large prepayment discounts
– Supervise the COGS
– Enhance the productivity of employees
– Optimize interest rates and taxes

Step 2 to business value boost: Optimize your net working capital

– Establish partnership relation
– Negotiate better payment conditions
– Optimize inventories and inventory turnover

Step 3 to business value maximization: Optimize your net investments

– Be aware of consumer trends
– Choose the right timing for acquiring new technologies
– Carefully plan capital investment – make investments that will support growth
– Increase the capacities in line with demand
– Ensure that the level of investments covers the growth potential
– Optimize financing

Step 4 to business value enhancement: Enhance your future growth potential

– Innovate with business model and come up with creative strategy
– Rethink processes and stick only to those that add value to your clients
– Develop new products and services

Step 5 to high business value: Minimize the risks related

– Keep the level of indebtedness at the level of comparable companies
– Endeavor appropriate product/service mix diversification
– Disperse your sales geographically
– Gain deals of appropriate size
– Supervise the creditworthiness of clients and suppliers
– Assure the level of fixed costs as low as possible
– Inform owners extensively and on a regular basis
– Give priority to transparency

Maximizing the business value is the most important criteria there is in running your business. For that reason it is important to follow the value of your company continuously, strive to bring the value maximization goals closer to the stakeholders involved, introducing the value based management techniques and setting up the KPIs based on business value maximization principles etc.

As a rational investor, one should always keep in mind also the exit strategy. The fact is that as an owner you will not be able to run or follow the company forever, so have a plan how you plan to divest your investment from the very beginning.

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Normally company receives equity financing in several rounds in order to motivate management and decrease the underlying investment risks.

If a company is worth 60 units (pre-money valuation) and an investor makes the investment of 20 units, the new, post-money valuation of the company amounts to 80 units. The ownership share gained in exchange for a new investment thus amounts to 25%.

In case of start-ups, the value estimation is due to high risk somehow vaguer. Therefore angel investors and venture capitals often offer certain investment amount for a particular ownership share based on their experiences and insights. Let’s say 25% for the investment of 20 units. However, by doing so, they have implicitly set the post-money valuation of the company to 80 units and pre-money valuation to 60 units.

This basic example illustrates the general concept. However, in reality the calculation of post-money valuation is more complicated due to convertible loans, in-the-money warrants and in-the-money employee stock option plans (ESOP).

In fact, the pre-money and post-money valuation should derive from the calculation of price per share multiplied by the total number of shares. Therefore, one has to consider the number of shares on a fully diluted and fully converted basis.

If the value per share increases compared to the previous round, then the investment is called an upround. It eventually means that the pre-money valuation is higher than the post-money valuation of the previous round. For the vice-versa case industry practitioners use a term downround.

The post Pre-money & Post-money valuation appeared first on Consilue.