Conversations about valuations

June 19, 2014

This article on valuation from the Houston Business Journal is written from the point of view of middle-market investment banking, but it’s also relevant to term sheet negotiations between entrepreneur and venture capitalist.  Higher EBITDA doesn’t automatically lead to higher multiples (and higher valuations).

The reality is that valuations are much more complex and are primarily a function of the underlying fundamentals of a business. These fundamentals might include growth opportunities, recurring revenues, customer and product diversity, entry barriers, proprietary products and high levels of free cash flow.  Our experience tells us that different buyers can have widely divergent views of value based on their relative assessments of these underlying fundamentals

It is important for private business owners to understand valuation drivers and to develop the financial and operating data that will enable buyers to properly assess the underlying fundamentals of their business.  More clarity for a buyer leads to a higher level of confidence and a more attractive valuation for the seller.

It also leads to a higher level of confidence in the relationship.  The early conversations about valuation (and control) begin to shape the personal chemistry crucial to a successful long-term partnership.  Clarity and transparency, which make it easier for everyone involved to observe how decisions are being made, are much more important to hopeful-future-teammates than either side trying to squeeze maximum value out of a single transaction.

If a good tone is set early and maintained consistently, over time everyone on the team worries less about who’s in control and more about how to create the best scoring opportunity.

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