How often have you seen “Dragon’s Den” hopefuls putting ridiculous values on their fledgeling business? They are trying to put a real number on all the passion, blood, sweat and tears that have gone into fulfilling their dream. They’re trying to turn something they’re 100% devoted to into a real number, and naturally the numbers that come out are enormous. But as we’ve seen, that’s not the same value that others will apply to it.
“Value” is a relative term – it really means “Value to a specific person in a specific set of circumstances”. Many years ago, after one of life’s inevitable down turns, I found myself completely skint; owing cash to a local thug and buying food with rubber cheques that, thanks to a wonderful invention called a cheque guarantee card, the bank would honour. As you can imagine, a five pound note had far more value then compared to now. However, that’s nothing compared to this incredible lesson in value: one red paperclip
100 years ago, most businesses were in or associated with manufacturing, and could be valued using their balance sheet because most of the value would be in assets – stock, buildings, machinery and debtors. A service business such as a web design or marketing agency has almost no hard assets – a few laptops perhaps, and so the only items of value on the balance sheet are the debtors (which should be low) and cash (which is normally low). The value of that business is its intellectual property, knowledge, skill and ability – none of which appear on the balance sheet.
At this point we’re going to make a bold assumption – that the principle owner of the business has very little day to day involvement in the delivery of the services. For a young creative business, this is almost never true. For an older business, if this is true, then you should consider it a serious problem – one that I’ve had a lot of experience with and will write about in detail soon.
I recently had the privilege of reading a paper about creating companies based on collaboration and not hierarchy by Doug Poretz (not currently public, sorry!), a model which is slowly gaining traction in modern creative companies. In the paper, the issue of valuing these intangible assets was the biggest problem in getting away from a traditional business model, because the future value of a business is the most important figure for its shareholders. However, I don’t think it’s a complex problem; I believe we already have a measure of the value of your intellectual property and skills – your profit. Consider any service business, and provided it is a working business, those assets translate directly into profit, and usually into recurring profit. For example:
- Web Designer: skill and experience are sold and become profit
- Software Developer: skill and experience become a packaged product which becomes profit
- even the dreaded Patent Troll: a portfolio of patents are licensed to others and become profit
The only time this doesn’t hold true is for a new business or one with newly acquired intellectual property. The value there is in future profit, with, of course, its associated risks. In this case, the value is very subjective and difficult to pin a figure on.
So far so good; we’ve found a monetary figure that is directly related to the value of your skill, experience, and intellectual property, but it’s not the “value” – value depends completely on the potential buyer. Let’s consider some of these buyers:
- A competitor wanting to put you out of business – value could be based on the expected increase to their business.
- A merger with a similar business – value could be a multiple of monthly or annual profit.
- A strategic purchase to gain skills or intellectual property – it’s unlikely that the business would continue as before, so all the value here is in the future profit that the buyer can get from the skills or intellectual property. That makes the value highly subjective – perhaps calculated as the amount the seller expect to lose, rather than the amount the buyer expects to gain.
- A venture capitalist – value could be a multiple of profit, but also based on future resale value – again, highly subjective especially as the seller is likely to be highly involved in the business, and therefore involved in generating that future resale value.
Now consider one more factor in all this – perceived value. Suppose you have a business that has a relatively low value if you look at profit and loss, but it has a patent, or has built some software, or an exclusive license of some kind. These are things which a buyer can see as potential future profit, and so they have a value based on how much profit the buyer thinks they can become, and how much cash they can risk to access that profit.