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How To Value A Supplements Business
This article intends to show readers how privately held supplement businesses are valued. If you own a supplement business and you want to understand what the process of selling one is like, you need to understand how prospective buyers value these types of businesses. Here, we'll explain how private company valuation works and make it relevant to supplement businesses. How Business Valuations WorkPrivate company valuations work differently than public company valuations. The stock market values publicly traded companies every trading day through the company's share price. To value a publicly traded company all you need to do is look at the number of shares outstanding and multiply that by the company's current stock price. This will show you the market cap for the business. Market cap shows us the total value of that company's stock (at the price it is currently trading at).
Private companies are harder to value than public companies. First, private companies do not share their financial information with the public. Second, they are not held to the same reporting standards that publicly traded companies are. So we can't value them with readily available information because they don't publish it.
There are four main ways that privately held businesses are typically valued. If you're looking to build a business with the intention of selling it, then it's important that you understand how prospective buyers would value it. Here are four of the most common ways private companies are valued:- Asset valuation method
- Discounted cash flow (DCF)
- Comparable company analysis
- Precedent transactions method
Before we get into how these valuation methods work, understand that the goal in private company valuation isn't to come up with an exact number. The objective is instead to use a variety of different valuation methods and to compare them side by side to see a range of prices that might make sense to pay for a business.
Now, if you're trying to sell the business, you want to try and get as much money for it as possible. So, your goal would be to get buyers to make an offer near the top end of that price range. In order to do that, we'll look at how these valuation methods work. As the business owner, you're in charge of the inputs that get you the outputs they're willing to spend the big bucks to acquire.
Before we get into how each valuation method works, it's important to remember that we're looking to approach a valuation from different perspectives. Typically, these various valuations are compared side by side. This is called a football field chart in the industry. This article here explains in detail how football field valuations work, and it has some great accompanying infographics. Understanding These Valuation MethodsNow that we understand that our goal is to approach a business valuation from several valuation perspectives, we'll look at how the four most common methods work.
First, we'll look at the asset valuation method. The asset valuation method is an approach used to estimate the value of a business based on the value of its tangible assets. This technique looks at the business through the lens that its value is determined by what it cost to create or build it, or through the replacement costs of its assets or the liquidation value of the firm. To calculate value via this method, add up the total tangible assets of the business and subtract any debt owed. The resulting figure is referred to as net tangible assets and should be considered when evaluating a company's worth. Itā?Ts important to note that this valuation method does not take into account cash flows, market share, or profitability.
Although the asset valuation method is common in private company valuation, it's less useful for supplement businesses because the value of their tangible assets will likely be negligible compared to their cash flow and growth potential. The next three valuation methods are excellent for supplement businesses.
So we'll look at the DCF method second. DCF stands for discounted cash flow. The discounted cash flow (DCF) method is a form of intrinsic valuation that attempts to assign a value to the business by attempting to value its expected future cash flows. This approach involves looking at the business from the perspective that it is an asset that will produce regular cash flows into the future. The DCF valuation looks at these future cash flows and discounts them back in time to their net present value. In order to perform a DCF valuation correctly, itā?Ts important to use the right cash flows and discount them back in time at an appropriate discount rate. DCF valuations can be quite complex. The good news is that anyone can learn how to value a business this way. This is also the most important valuation method for a supplement business and we highly recommend this blog post to learn more about how DCF valuations work.
The next two valuation methods are forms of relative valuation. This means that they assign value to a business by looking at comparable market data in two different ways.
Next, we'll look at the precedent transactions method, which is a type of relative valuation technique whereby historical data from prior mergers and acquisitions (M&A) deals is used to establish the value of similar businesses. This approach looks at transactions where the acquiring company has paid a premium above earnings to acquire their target. So, if a similar business sold for eight times its EBITDA, then we can argue in a negotiation that our business is worth that as well because another acquirer paid that for a similar business.
Finally, comparable company analysis is another form of relative valuation that can provide a useful alternative perspective. While this is a second type of relative valuation, this method is different than the precedent transactions method because there we looked at similar private companies and now we're looking at similar publicly traded companies. This approach seeks to assign a value to the business by referencing similar companies that are publicly traded. Here, we look at what those similar companies are trading at above earnings, and we value our company based on that. In order to use this method of valuation effectively, we need to make sure we're looking at similar companies. If they aren't truly comparable, then this valuation won't make sense. Second, we need to make sure we account for the fact that these valuations will be high because they are for publicly traded companies. Investors prefer liquidity and it's much easier to sell shares via the stock market than it is to sell an ownership stake in a privately held business. We call this a liquidity discount in valuation. SummaryIn summary, supplement businesses will likely be valued initially with the DCF method. This will value the business based on its expected future cash flows, which is important because that is most likely what the acquiring company is looking at this supplement business for. To convince prospective buyers that your business' future cash flows are valuable, make it a point to drive repeat business. You would want to be able to make a case that a high number of your customers are loyal to your brand.
Additionally, both the precedent transactions method and comparable company analysis are excellent valuation methods for supplement businesses because there are many bought and sold each year and there are also plenty of publicly traded companies selling supplements that can be referenced as well.
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