Creating Enterprise Value in Startups
There are myriad ways to value a company, all of which are susceptible to push back. This is because valuing a business is an art, not a science. When dealing with startups and to an extent SME’s, this issue is complicated because historical data to inform the valuation won’t exist.
Dragon Argent look at the benefit of building Enterprise Value (EV), regardless of an entrepreneur’s timeline or intent to sell, and how this can serve to both enhance and qualify a valuation when the time comes to raise investment or plan an exit.
EV is a measure of a company's total value. While some approaches like discounted cash flows can be used to value both start-ups and established firms, other metrics like cost-to-duplicate and stage valuation are unique to new ventures.
Key to optimising EV and ensuring any future exit process is effective and efficient is to proactively:
Understand the key drivers of EV by identifying what investors or acquirers look for and how they value prospective investments or acquisitions
Objectively assess how your business compares relative to those drivers to identify risks that need to be mitigated or opportunities that need to be maximised
Identify, prioritise and focus your businesses resources on the actions and initiatives that will deliver the greatest impact against those drivers
These factors will cover culture, people, processes, systems, product, price, place, competition, customer base, revenue, accounts, legal etc. It is an exhaustive list that must be analysed and prioritised to build a coherent and comprehensive strategy. The factors that drive enterprise value will be specific to each business and the market they operate in and must be built from the ground up. Even when they have been identified, it requires a committed ongoing effort to mitigate their risk or maximise their value. Some examples are outlined below:
Establishing a shared long-term objective. In any startup or SME it is essential that the key shareholders and leaders achieve consensus over the long-term objective of the business. Once this has been agreed, it can be used as a point from which to reverse engineer the enterprise value required to realise that objective.
Identifying potential acquirers and their motivations. It is essential that shareholders understand who is likely to acquire their business and for what reasons. The obvious answer is a direct competitor but often it is less obvious businesses with adjacencies to yours which creates a more compelling business case. Are they acquiring to increase revenue, benefit from R&D, secure talent, enter a new market or location? How can you strengthen that proposition to make a compelling commercial business case?
Reducing reliance on single stakeholders. Ensuring that there isn’t an individual business leader, employee, customer or supplier that a business’s success is dependent on is key to driving enterprise value. Over dependence on any individual stakeholder represents significant risk to a potential acquirer and will therefore reduce a valuation.
Diagnosing financial health. Ensuring that regular management accounts are prepared for the leadership team to inform decision making is essential. The health of an organisations accounts is one of the most influential factors to drive value, so having an innate understanding of your cashflow and balance sheet will enhance financial due diligence.
Product-market fit and go-to-market strategy. To what degree does your proposition satisfy a market demand and what is the addressable size of that market? Have you developed a best practice strategy to communicate the value of that proposition to your target market? Being able to communicate this through commercial due diligence is essential for startups to drive valuation
It is critical to get external perspectives when going through this process. Research with investors, potential acquirers, M&A advisors and consultants will help inform your EV strategy and exercises such as Hoshin Kanri matrix will help provide structure and performance indicators.
Finally, a caveat. Whilst the above represents some best practice steps that can be taken to maximise enterprise value, often a startup company’s value is dictated by the market forces in play today, and today's perception of what the future will bring. So founders can’t control all the factors that drive enterprise value!
If you would like support and advice on how to drive enterprise value in your organisation, please get in touch.