It’s an interesting question and one which we are often asked when talking with businesses of any size. With one eye on an exit and the other on the long haul, an early sale can be the solution to the perpetual challenges for any entrepreneur running their own show.
Uber is a typical “unicorn”, a fast ride of growing revenues, a history of losses and a market capitalisation of over $1 billion dollars. Technically Uber is a “Decacorn” a market cap of over $10 billion, well on the way to becoming a “Centicorn”, a start up with a market cap of over $100 billion dollars.
According to CBInsights, there were over 200 Unicorns around in 2017. Top ten “Decacorns” included Uber, Airbnb, WeWork, Snapchat, Pinterest and Uber rival Lyft. Top Unicorns included Stripe, Spotify, Slack, Transferwise, Funding Circle and Coinbase.
Brewdog scraped into the list with a market cap of $1 billion dollars. Not bad for a Scottish craft brewer with sales around £100 million last year. Now Brewdog has been overtaken by Deliveroo, valued at over $2 billion dollars. The restaurant delivery vehicle reported losses of over £18 million pounds in 2016, with a still yet unproven revenue model.
So why the excitement and the extreme valuations? High growth, high tech “platform’ businesses are the route to high expectations and high valuations. The “Empires of the Cloud” led the way. Google, Amazon, Facebook, Apple and Microsoft now have a combined market valuation of $3.5 trillion dollars. Apple alone may hit the $1 trillion valuation this year. The Apple “enterprise” value (Market cap plus cash in hand) in January 2018 is $940 billion.
Apple has history, revenue and profits. The PE ratio, ie the ratio of price to earnings applies. It is a key ratio in determining market valuations. For Apple the PE is 19. Apple is considered to be a “maturing” stock. Microsoft, PE 23; Google, PE 26; and Facebook, PE 36; have higher valuation ratios still. Amazon, never a company to obsess about profits until the company discovered AWS, has a forward PE in triple figures. It is 155. Yes one hundred and fifty five as we write.
So how do we value a growing business? A horse with a horn is not a unicorn.
First make sure you have valid business model. Realistically generating cash and profits having made full provision for directors costs prior to striking the bottom line. If you are in the “investment phase” make sure you have assessed the burn rate and runway length to get your business off the ground before you run out of cash.
Investors will address the growth rate and potential growth rate of the business, size of market together with the vulnerability of the market to competitor reaction.
There was a time when net assets featured in a business valuation but rarely is this relevant in a young business especially a platform business. Profits will be taken into account to generate the valuation with an appropriate PE multiple. Free cash flow is important. Issues of depreciation, interest, tax and other amortisations are added back to deliver the EBITDA number which is then used with the appropriate multiple.
How big will the multiple be? That really is a function of profit margin and growth rate. The PE ratio in some ways reflects the growth potential of the business. As the growth rate slows, and the laws of the market determine it will, so too does the PE ratio.
In public companies, the PEG ratio is published in market analytics. The PEG ratio measures the relationship between the growth rate of the business and the PE ratio. A high PEG ratio suggests an overvaluation. That’s where the PE ratio is higher than the growth rate. Conversely a low PEG ratio where the PE ratio is lower than the growth rate, may reflect a relative under valuation.
Discounted cash flows will feature in valuation models along with peer group comparisons. If the race to sale, becomes competitive, DCFs are discarded. Peer group pricing will peak and the greater fool theory will come into the valuation model. The price of anything is as much as a greater fool will pay. This latter technique rarely features in the text books but featured in the great book, “Barbarians at the gate” the story of the race to buy RJR Nabisco in 1988. What a race to sale that was!
Confused? It’s always best to take professional advice. In pro-manchester we have the largest corporate finance and private equity group outside of London. The community comes together on the 15th February for the Annual Corporate Finance Lunch. It’s a great chance to meet with professional advisers and receive lots of tips and advice in valuing your business. Many will be there to offer great advice.
About the Author: John Ashcroft
John Ashcroft is CEO of pro-manchester and a visiting Professor at MMU Business School. He specialises in Economics, Strategy and Social Media.
January 9th, 2018