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Knowing the value of a company is essential to a business owner during many decision-making processes in the early, high-growth years of a business. Business owners need to have an accurate estimate of a company’s value to make the best decision when dealing with topics such as capital raising, compensation to key management (including potential equity incentive plans), and even inquiries from potential acquirers. Due to the fast-growing and rapidly changing nature of many new businesses, valuing these companies comes with a plethora of challenges. Additionally, oftentimes new and innovative companies operate within entirely new industries (think Uber, Airbnb, etc.) in which typical valuation practices may not be appropriate or may have to be heavily modified. Below are a few nuances we often encounter when valuing high-growth businesses.
- Limited Historical Information and Speculative Forecasts. Since fast-growing companies are often very new businesses, there is limited historical financial data to rely on for estimating “normal” company performance, and frequently, these companies have yet to generate substantial positive cash flow or sustainable profitability. As such, valuations of high-growth companies are inherently forward-looking and accurate forecasts of future cash flows are essential for an accurate valuation. Properly accounting for the speculative nature of management’s forecast – and considering both upside and downside scenarios – is essential to developing an appropriate estimate of value.
- Lack of Comparable Companies. Market-based valuation techniques that utilize data from similar publicly-traded companies or from recently acquired private companies are widely used due to the ability of these methods to account for industry-specific characteristics such as risks, profitability, and growth. However, since many fast-growing companies are very new and may be establishing the very industry that they operate within, comparable companies may be very difficult to identify, thus limiting the usefulness of multiple-based methods.
- Complex Capital Structures. Newly established businesses often incentivize key management members with various forms of equity participation including synthetic equity plans, stock appreciation rights, stock options, warrants, etc. In addition to the inherent difficulties in valuing the operations of a company, equity incentive plans often add a layer of valuation complexity due to the creation of different classes of equity. Different classes of equity can result in asymmetric returns to equity holders of different equity classes, which often necessitates the use of complex valuation techniques such as option-pricing models or Monte Carlo simulation. Further, many equity incentive plans are subject to various tax and financial reporting requirements such as 409A and ASC 718, which often facilitate the need for a well-documented valuation opinion.
Overall, challenges involving valuing new, fast-growing, and innovative companies stem from the fact that they are ever-changing over their short history and will likely continue to change over the near future. Predicting these changes and their impact on a company’s value requires in-depth comprehensive analysis and a deep understanding of the company, its leadership, and its overall direction within its industry. An accurate valuation is an integral piece of information for business owners of high-growth companies to continue making the best decisions for the company. At GBQ, we have vast experience valuing these dynamic businesses and are eager about any opportunity to partner with leadership of fast-growing companies to assist in empowering the growth of innovative and exciting businesses.