Out­look Sur­vey

Finweek English Edition - - MONEY -

Over a year ago we started this col­umn with the idea of help­ing en­trepreneurs un­der­stand more about what drives value in a busi­ness and how to in­flu­ence this so as to build a more valu­able busi­ness.

To re­cap, the value of a busi­ness to­day is based on its ex­pected fu­ture re­turns (free cash-f low gen­er­a­tion) dis­counted by the amount of risk to the cap­i­tal em­ployed.

A busi­ness sources cap­i­tal from eq­uity in­vestors and by bor­row­ing money (debt) from lenders like banks, so in val­u­a­tion cal­cu­la­tions we dis­count fu­ture cash f lows by the weighted aver­age cost of cap­i­tal (WACC). This is the af­ter tax cost of debt mul­ti­plied by its pro­por­tion of cap­i­tal em­ployed, added to the cost of eq­uity mult ipl ied by it s pro­por­tion of cap­i­tal em­ployed.

Gen­er­ally, any debt is se­cured against an as­set and is re­paid from prof­its be­fore tax. Then taxes are paid and only af­ter­wards does any sur­plus get passed on to the eq­uity in­vestors.

Like­wise, if the busi­ness runs into trou­ble and is liq­ui­dated, the eq­uity in­vestors are the last to get any money out.

So, what this means is that the cost of eq­uity cap­i­tal is high­est be­cause it’s at the great­est risk. The cost of debt is the amount your com­mer­cial bank charges you on loans longer than a year. It’s easy to cal­cu­late – just read your bank state­ment. re­late this all back to long-term Trea­sury bond in­ter­est rates in the US. There are fancy words we use in fi­nance, like ‘ beta’ and ‘syn­thetic beta’, and math­e­mat­i­cal for­mu­las used to cal­cu­late them.

What’s hard to get right in big listed com­pa­nies be­comes im­prac­ti­cal in the SMB mar­ket, so for SMBs the ap­proach taken is one of two – ei­ther the eq­uity in­vestor says: “I need a re­turn of at least 30% in my fund, so let me dis­count by that amount and see if the num­ber re­mains pos­i­tive,” or the pri­vate in­vestor says: “Given what I know about the risk of the busi­ness, I want a re­turn of 20% on my money, so let me dis­count by that amount and see if the num­ber is pos­i­tive.” In both cases, th­ese are very sub­jec­tive num­bers, whose prac­ti­cal ap­pli­ca­tion is re­ally limited to large funds and ex­pe­ri­enced in­vestors.

How can you de­ter­mine the ap­pro­pri­ate cost of eq­uity cap­i­tal for your busi­ness?

Well, over the past 16 months we’ve been work­ing on scor­ing risks in a busi­ness and try­ing to come up with an ap­pro­pri­ate cost of eq­uity that you can use in val­u­a­tions. We’ve been look­ing for a way to do this that of­fers not only a re­li­able es­ti­mate for any SMB, but also al­lows a big­ger fund or in­vestor to com­pare risk and costs of eq­uity across sev­eral busi­nesses, even those op­er­at­ing in dif­fer­ent coun­tries.

What we’ve de­vel­oped is a sur­vey tool. We call it the ‘Fu­ture Out­look Sur­vey’ be­cause it’s about the fu­ture and strat­egy as well as about risk. The sur­vey takes about 15 min­utes to com­plete, is dead easy, and you’ll be able to ac­cess the re­sults for free. The re­sults in­clude an over­all risk score for your busi­ness (com­pared to its in­dus­try peers) and a sug­gested cost of eq­uity cap­i­tal that you can use in your own val­u­a­tion cal­cu­la­tions/in­vest­ment de­ci­sions.

All you need to do is reg­is­ter on www. val­u­a­tionup.com, add your busi­ness and an­swer the ques­tions. Your re­sults are conf iden­tial. If you in­vite oth­ers from your in­dus­try – your cus­tomers and sup­pli­ers, even your com­peti­tors – you’ll get to see how your risk com­pares to the in­dus­try aver­age (and how your sug­gested cost of eq­uity com­pares to the in­dus­try aver­age).

Over time, we hope to build up a zeit­geist of each in­dus­try in each coun­try, in­clud­ing com­men­tary from busi­ness own­ers around spe­cific risks, trends or op­port u nit i e s . We’ l l s ha r e i ntere s t i ng in­for­ma­tion as it be­comes avail­able.

How risky is your busi­ness? What re­turns should you be look­ing for on your eq­uity cap­i­tal given this risk? Where should you fo­cus ef­forts to lower risk and in­crease your val­u­a­tion? Find out for free on Val­u­a­tionUp.com.

Gareth Ochse is founder of Val­u­a­tionUp. com – a fi­nan­cial anal­y­sis and strat­egy tool that shows how a busi­ness is be­ing run, what it’s worth, what it could be worth and how to get it there. Email fin­week@val­u­a­tionup.com with any feed­back/ques­tions.

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