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The value of any investment is driven by its ability to provide a future return to that investor. This concept forms the basis for various valuation approaches (i.e., discounted cash flow), however also extends to various “rules of thumb” that are often used to roughly estimate business value through multiples of EBITDA, earnings, cash flow, etc.
While this generally holds true, there are thousands of businesses in the U.S., in various industries and dynamic financial outlooks. Some of the businesses with a recent history have little or no profitability. So, if future returns are the source of a company’s value, is a new business with no profitability worthless? Most of the time, the answer is no. In fact, businesses that have generated no profit from operations could still have significant value – here are three examples:
- The company has not realized its full potential. New businesses are formed every day, and often times these new businesses have operating losses for many years until the employee talent is hired, products are developed, customers are gained. Therefore, even a business with losses may be valuable, especially if that business is on the right growth path and has begun to develop tangible and intangible assets that can drive cash flow over the long-term. This is often what drives sky-high values for start-up tech companies.
- The company has a significant asset base. Some asset-intensive businesses are better evaluated by their asset base rather than their earnings generation since at the very least, a prospective buyer could potentially liquidate these assets.
- The company has value for a strategic buyer. A company that is not profitable on a stand-alone basis may have value to a competitor or another company through synergies created by its acquisition. These buyers may be able to eliminate expenses or generate new revenue opportunities, either for the target company or the acquiring company. Typically, a business must provide strategic value to two or more companies in order to command this strategic price.
These examples emphasize why a valuator must sometimes look past historical or current profitability in determining business value. Since there are numerous factors to consider when estimating the value of a business, it is generally advisable to seek a qualified outside opinion. GBQ Consulting’s valuation team issues hundreds of opinions annually on the value of businesses, business interests, and intangible assets of both privately-held and publicly-traded companies, for a variety of purposes.