| “All Company Valuations Are Not Created Equal ” |
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by Dennis L. Monroe |
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from June-July 2006 Franchise Times |
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“What is the value of my company?” is a question I am frequently asked. In the franchisor world (whether it be franchisors or franchisees), we usually focus on a multiple of earnings. In recent times the multiple of earnings have been going up; and there has been a feeding frenzy as it relates to the purchase of franchise companies.
What determines the value of a company? We normally look at the valuation in terms of a third-party sale. However, there are other times when we look at valuations for purpose of financing, estate planning, management compensation and other events that may necessitate a valuation.
There are a number of valuation firms in the country. I wanted to go to someone who is known for valuing businesses of all kinds and for various purposes, not just someone who values franchise businesses, because they can be formulaic in their approach. I had the honor of recently speaking with Mike Bochert, a Managing Director of Cherry Tree Companies, a 25 year old investment banking and investment management firm. Mike is a long-time investment banker and valuation expert of private companies, whether very small or very large.
Dennis Monroe question: How are company valuations not alike?
Mike Bochert response: To understand why all company valuations are not alike, think “P-C-A.” In other words, valuations vary in Purpose, occur under differing company Circumstances and each is directed to a specific Audience. Each of those variables has an effect on the judgments and considerations which are appropriate for any valuation.
Without trying to be exhaustive, the Purpose of the valuation could be:
- Determining value pursuant to a buy-sell agreement
- An estate valuation
- Obtaining growth financing
- Acquiring another multi-unit business
- Considering being acquired
- Strategic decision making
The company’s Circumstances might be:
- Profitable company with substantial growth opportunities
- Franchisee with multiple concepts, one performing well and one performing poorly
- An economically strong operation which is considering the acquisition of another operator
- Troubled operation considering an acquisition by another operator
The Audience for the valuation could be:
- Private equity firm
- Mezzanine financing firm
- Internal Revenue Service
- Litigation attorneys
- Management or Board of Directors
Dennis Monroe question: Mike, that all sounds great, but can you give me a couple of examples of where you can apply this P-C-A theory?
Mike Bochert response: For example, consider these three valuation situations.
- Additional equity for substantial expansion (“P”) is sought by a successful company (“C”). The money will come from a private equity firm (“A”).
- The valuation of the company in this case is a function of the rate of return the private equity firm requires on the money it will invest, how much of the investment is equity versus debt, and its expectation about the future growth of the company, coupled with when and how the private equity firm believes it will be able to cash out. Real estate values or current public market multiples may have an influence, but are not the critical issues.
- An acquisition (“P”) of an undercapitalized and only modestly successful operator (“C”) is being considered by the franchisor (“A”).
- Of course, this valuation needs to take into account the financial results of the target company. However, two other broad considerations should be given heavy weight and could materially increase the realizable valuation. One is the potential interest that a well capitalized operator of the same franchise might have as a way to expand its territory. Another is the benefit to be realized by the franchisor, if, by acquiring the target, it gains access to an underdeveloped territory and an operation that could become much more profitable with more efficient management.
- An estate valuation (“P”) in which a key asset is the majority ownership of a $50M revenue, heavily debt laden franchisee (“C”). The valuation follows the death of the operator and is required to satisfy the IRS and its valuation expert (“A”).
- As above, the historical financial performance will be important. However, the valuation will also need to take into account the importance of the deceased operator to the business and the riskiness of the financial structure caused by the debt.
Dennis Monroe question: What should you look for in a valuation firm if you want it to do more than just whip out a quick result based on the latest transactions?
Mike Bochert response: Look for a firm that can demonstrate it has (i) broad knowledge and experience in the capital markets, including managing transactions, and not just a database with information on some recent transactions, (ii) an ability to thoroughly analyze the financial and operational characteristics and prospects of the business, including the company’s specific capital structure, (iii) an understanding of the importance of the P-C-A approach to valuations, and (iv) the professional stature and personnel to defend the valuation, if it is challenged.
Dennis Monroe question: How often do you think a valuation should be updated?
Mike Bochert response: The purpose should suggest the timetable. For estate planning or strategic decision making purposes, an annual valuation might be appropriate. For buy-sell agreement purposes, that document may dictate how current the valuation should be. However, keep in mind that a thoughtful, defensible valuation may require four to six weeks to complete.
Readers, I hope this interview has given you some insight into the unique usages and qualitative differentiations of valuations. When you are looking to value your company in the future, remember it is very much a contextual process; and all valuations are not created equal.
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