How to appraise a business: tips for investors
There are many tools to assess a business performance. Some of them require specific knowledge and not every entrepreneur can effectively operate without an external aid. What aggravates the situation is that many terms being used are English borrowings. For example, many Ukrainian experts often borrow such English words as ‘costs’, ‘fixes’ (fixed assets), ‘fee-see-fee’ (FCF, free cash flow). This terminology can be confusing for a person unprepared.
However, things are not as bad as they may seem. There are some key and simple rules of business valuation that never fail. Focus on them if you plan to close an M&A deal or investment in a company.
First and foremost, one should pay attention to how things are going in the industry wherein your targeted company operates. Its economic prospects for the future, key players, potential competitors, dependence on political and other factors. These and other data allow us to understand what problems they will face and how effectively they will solve those problems. That said, investing in a potentially lucrative industry is a safety cushion of a sort: even if a company is not the most successful, there is a high probability it will generate surplus due to its successful performance and industry popularity.
Of course, it is better to invest in industries that use operating principles well-known to you. All professional investors do that because their own knowledge allows them to assess risks better. But with no first-hand experience available, you can always turn to independent analysts. However, it is important to have guarantees that you will be provided with up-to-date and unbiased data. Therefore, contractors should be chosen with care. Kreston GCG is always ready to provide assistance in this matter. We have a strong track record in business valuations and external fundraising.
First, you need to look at a company’s performance within the market segment. Does it take market risks into account? How effectively? Does it have a strategy to extend its coverage and dominate other segments? If there is one, what are the timeframes? Are these timeframes realistic?
Another important aspect is the customer management. Examine business plans, communication tools, marketing campaigns aimed at attracting new customers. Realizing how the company intends to retain existing clients is just as important. The smarter and more advanced this issue is thought-out, the greater the enterprise success is.
These criteria are especially important for startups. If an aspiring company has no clear understanding of how to work with their audience, no doubt it will fold up. Even the best ideas fail if sold poorly. This rule, unfortunately, always works.
When investors come to the market, financial statements are their first priority. Balance sheets, financial position statements, cash flow are all that matters. These documents reflect the financial stability of a company.
Industry awareness is particularly useful here. It is easy to get confused in a vortex of figures and lengthy wording or discard an important detail as insignificant. For example, in a subscription-based publishing business, financial statement may contain an item “deferred subscription debt”. An industry-unaware accountant is likely to misunderstand its importance and will probably pay no attention. This item, however, is very important as it can contain hidden assets.
It is also important to see how often companies attract third-party investments and how well do they use the funds raised. If investments are often, one has to know if the company is overvalued by investors.
A striking example is a busted startup Jawbone that specialized in fitness trackers. It had been successful for a long time with its products ranked in the top ten. Over time, Jawbone started lagging behind competitors and IT giants: Apple, Samsung, Fitbit. No matter what, investors continued to invest in the company believing in its name and past success. At the same time, many professionals left the startup and allegedly took some corporate secrets about certain developments. Jawbone even sought legal redress, which was exhaustively covered in the media. These events did not stop the company from raising US$900 million and… closing the business down. New products were commercially unviable. Betting on the name, as we can see, did not pay off.
Trust is an obvious but no less an effective one. If you have any doubts about the company management, its competency, commitment to future success and ability to see through the business – it is better to avoid risks. Business efficiency does not depend on financial indicators and strategies alone. It rather depends on the owner’s fascination with the trade and their readiness to work hard and grow. Such people are always able to achieve higher results and raise up to the challenges.
If you plan a large investment or a deal, and if you find yourself unable to value a business, Kreston GCG is ready to offer its services. Find the details and our projects in the relevant section on our website.
This post is also available in: Russian