How Much Is Your Company Worth?

By Robert Mullins
Staff Reporter of The Business Journal.
From The Business Journal Online

The task of estimating his company's worth so he can secure financing for it involved a bit of "black art" for Michael Wieczorek.

"The valuation is what you think someone is willing to pay to buy the company," said Wieczorek, president of Extrusion Control & Supply Inc., Milwaukee, which manufactures and distributes parts for polymer plastic making machinery.

While that explanation seems simple enough, coming up with a valuation number is tricky, especially for a small business.

 

There are commonly accepted formulas for estimating the value of a company, but many variables. And because a business valuation is based on historical performance, a young company has little history to show for itself.

 

Still, there are ways to determine the value of a small company to secure second-stage financing from venture capitalists or other investors, as Wieczorek found.

 

Wieczorek values his company at $4 million to interest venture capitalists. He made a pitch March 13 before the Wisconsin Venture Network for a $450,000 equity investment in his 3-year-old firm. With the money, he thinks his firm, which generates $500,000 in annual sales, would reach $5 million by 2004.

 

Initially, he pegged the value at $10 million, but advisors told him the formula he used was more suited to public companies than private. Private company valuations are typically based on a multiple of between six times and eight times earnings, he said. Projecting out what the earnings would be for Extrusion Control & Supply five years from now gave Wieczorek that $4 million figure.

 

His valuation was tempered by how much he was willing to seek from outside investors.

 

Wieczorek is willing to give up only 40 percent ownership in his company for the $450,000 equity investment. He could have asked for more money, which would have propelled the company further and boosted its valuation. But Wieczorek wanted to retain majority ownership.

 

"Control was a limiting factor," he said. "I got into this business to be my own boss."

 

"But control issues may, concersely, limit the interest of investors in venture capital deal," said Doug Mitman, a partner in Grace Matthews, Inc., a Milwaukee venture capital consulting firm. Mitman is not involved with Extrusion Control & Supply.

 

"The more a venture capitalist owns of a company, the greater the capitalist's rate of return if the company is profitable," Mitman said. "A capitalist may want majority control of a company to justify the investment."

 

"There are other valuation issues besides majority ownership," Mitman said.

 

For instance, the value of a small business may be hard to gauge if it has little history.

 

"It may not have earnings, so you have to base the valuation on future opportunity," Mitman said.

 

"Assessing that future also is hazy, depending on the business it is in." he added. "The projected valuations of traditional companies, such as manufacturers, may be fairly modest compared with those of technology firms."

 

However, a small company's valuation in any industry can improve if it has competent managers.

 

"People with ideas are called entrepreneurs. People with ideas who are good at executing them are called millionaires," said Mitman.

 

Investors have more confidence in an entrepreneur who started his own company after serving for many years as chief executive officer of another company in the same industry than someone who is merely ambitious.

 

"Management is a critical component for early-stage financing," he said.

 

Wieczorek has 10 years of business and technical experience that he brings to Extrusion Control & Supply. He also touted the experience of his lead inside sales person and one of his machinists and plans to bring in other talent.

 

But while he has put a lot of work into his venture capital proposal, he's still waiting for a response.

 

Since his March 13 presentation at the Wisconsin Venture Network Equity Forum, Extrusion Control & Supply has received a few inquiries but no formal proposals from venture capitalists interested in buying into his company.

 

"If I had just put 'dot.com' in the name of the business, it might get more interest," Wieczorek said.

 

"Venture capitalists tend to take an interest in companies with the greatest growth potential and may not have companies such as Extrusion Control & Supply on their radar screens," said Steven Turner, Managing Partner of CapitalKey Advisors Inc., a New York City investment banking firm.

 

But a company with a solid business plan and competent management can still arouse some interest.

 

"I wouldn't try to discourage that guy," said Turner. "There are all sorts of venture capitalists out there and they may find a sweet spot (in that company)."

 

Robert Mullins can be reached at (414) 278-7788 or rmullins@amcity.com.