Planning, Startups, Stories

Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

5 Things Entrepreneurs Need to Know About Valuation 2

Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.

  1. The word has vastly Different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
    1. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
    2. What a business is worth to a buyer. Small businesses go up for sale with  business  brokers. Hardware stores, for example,  get about 40-50% of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
    3. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50% of your company, you just proposed a valuation of $2 million.
  2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
  3. For Small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like  recent growth,  and discounts for negatives like lack of growth. You could read up on it in,, or business brokerage press. Or do a web search and check the ads for valuation experts.
  4. For Startups, it’s what founders and investors negotiate. Startups and investors and culture clash over valuation.  Investors care about valuation. Founders often misunderstand valuation. And never the twain shall meet. I’ve seen these kinds of problems many times:  Founders walk into the valuation discussion full of folklore and fantasy like stories of Facebook and Twitter. They want lots of money for very little ownership. Investors see two or three people with no sales history thinking their dream startup is already worth $2 or $3 million.
  5. Irony: sometimes traction, and revenues, make things worse. It’s easier to buy the dream than the reality. The same investors who’ll seriously consider a $2 million valuation for a good idea, business plan, and a credible 3-person management team – but with no sales ever — might just as easily balk at a valuation of $600,000 for a company with three years history, 20% growth, and annual sales of $300,000.  Despite the irony, it makes sense: few existing businesses are worth more than a multiple of revenues, but, still, before the battle, it’s easier to dream big. Or so it seems. I’ve been on both sides of this table, and I don’t have any easy solutions to offer.

If it hasn’t come up yet, it will. Every business deals with valuation eventually. The place any business sees it is during the early investment phases; but most businesses don’t get investment, so they can ignore it at that point. But then if it survives, or grows, valuation comes up again, because even if the business is immortal, the people aren’t: so eventually you either sell it or pass it on to a new team, an acquiring company, or your own family. And there’s the divorce and estate planning elements that require valuation. So every entrepreneur and business owner should have some idea what it is.

(Image: courtesy of

Planning, Startups, Stories

Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

True Story: Dollars vs. Eyeballs in Business Valuation 2

It was a warm late-spring day in 1999. I sat in my office with a venture capitalist, my lawyer, and my son. The sun beamed in the patio outside my office. We talked about Palo Alto Software and its web subsidiary At one point the VC said:

You wouldn’t be an attractive investment for VCs. You’re too profitable.

I chuckled. I thought it was a joke. We’d grown sales in four years from less than $1 million to more than $5 million annual sales. We had to be profitable because we had no outside money.

He said:

That’s no joke. It’s like the Oklahoma gold rush, a land grab, and the assumption is that if you’re profitable, you’ve stopped too soon. You should be spending more to build traffic.

Those were strange times.

(Image: iDesign/Shutterstock)

Planning, Startups, Stories

Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

BizEquity Adds Tools for Estimating Valuation 0

I’ve posted here before on BizEquity, the “Zillow of small business valuation” site offering quick estimates of business valuation.

BizEquity founder Tom Taulli — a true expert in the field — has added some interesting new tools for the site. Most notably, a valuation wizard that can take your inputs and give you a quick and dirty estimate of what your business is worth.

I did a test run over the weekend, by inventing hypothetical numbers for an Internet company. I had it started just three years ago, growing sales to $350,000. It had little or no profits, a bit of debt, and a lot of dependence on the owner (the site’s auto wizard asked me the right questions). The estimate ended up at about $275,000, with interesting variations above and below that depending on how I set several sliders. You probably can’t read the details in the shrunken illustration below, but the sliders are asking how favorable the location is, the level of competition, and how you foresee the future financial performance.

Bizequity input

With the way the sliders work, you can see instantly how valuation would change with different settings.

Obviously, these are just estimates. As with estimates of house values, before you list your house, these estimates give you some idea, but are far from exact. They’re based on some standard formulas that estimate valuation using factors like sales, profits, assets, liabilities, and so forth. Don’t even dream of using this for a tax-related valuation, which requires a certified valuation professional; but it’s still a useful first look.

I think valuation is fascinating. What is a company worth? With the larger publicly traded companies you can easily calculate a valuation using the wisdom of the crowd, the market itself, by multiplying shares outstanding times price per share. But in the real world of small business, gulp, this is much harder.

Concretely: how much is your business worth? How much could you sell it for? How would you decide? What formulas would you use? More importantly, what formulas would your hypothetical or theoretical buyers use?

Ultimately, like it or not, just about anything is worth what somebody else will pay for it. Your business is worth what you could sell it for.

And what would that be? Well, that’s really hard to know, until you go to the market. Some people talk about 5 or 10 or more times profits, but then face it, in small business, in the real world, profits is a very vague number, an accounting conceit. Some people talk about 1 or 2 or more times sales, which eliminates a lot of the accounting fiction. Others talk about valuations based on book value, or assets.

I’m amused at how much of this stuff is loosey-goosey, even though it’s in the realm of finance, which is supposed to be mathematical and exact. And isn’t.

I posted here last Fall about, Tom Taulli’s really intriguing site that’s attempting to create a database of first-cut estimated valuations of businesses all over the United States. I talked to Tom last month after the big meltdown, and found, happily, he’s still optimistic about the long-term value of the BizEquity site. They’re working on it. I suggested he take his September data and multiply it by about 0.5 or so; and I was only partially joking. Tom knows this area very well, but of course the whole volatility burst has been a challenge. Last summer might not have been the most opportune time for Tom and his backers to start.

So I was interested yesterday Monday morning as I soaked in coffee and I noted — thanks to Ann Handley in Twitter — Advertising Age‘s Simon Dumenco’s angry analysis of the Huffington Post’s recent venture capital infusion at a valuation of $100 million.

His title, unfortunately, is What’s $200 Million Divided by 2009 Reality. That’s too bad, because the $100 million (or less) estimated valuation was widely publicized when Oak Investment Partners announced the investment last November. Simon doesn’t enhance his argument by referring to the twice-as-large-as-fact figure, $200 million, that actually appeared much earlier, last Spring. The phrase “straw man” comes to mind.

That glaring error aside, he seems offended by the VC’s reported valuation. He has references to the big Internet bubble of the late 1990s. It should be only $2 million, according to him.

I think he exaggerates his point, not just by doubling the figure, but also by lowballing his real estimate. The Huffington Post has made huge (and well reported) gains in traffic. Furthermore, unlike a lot of the Web 2.0 sites he wants to knock, this one has an actual revenue model. For better or worse, the Huffington Post is almost like old-fashioned media. It generates readers with news and opinion, and it sells advertising. So somewhere in the numbers — which are not public — is a number for revenues, and a valuation based on (among other things) revenues as well as traffic.

And it all goes to illustrate my point, today: valuation is hard to figure. It’s also important. And, in the end, a company is worth what buyers will pay for it. In the case of Huffington Post, it’s not a vague theoretical guess. The VCs who invested in Huffington set a price, and, with that, a valuation.

The best readily-available valuation of business consulting services is 1.12 times annual sales. For automotive repair shops, it’s .41 times annual sales. Physical fitness facilities are going for .66 times gross annual profit. Grocery stores are going for .28 times annual sales, and sporting goods stores for .34 times annual sales.

There’s a valuation report in Inc Magazine’s April issue that turned me on to Business Valuation Resources, which sells information like the above, culled from data on actual transactions.  I registered (free) to get a free download of a complex chart — sophisticated, innovative, imaginative, but really hard to read. And I gather that the underlying data isn’t cheap, because I can’t find anywhere to send you for a link to the data table, industry by industry, that I used to do the snippets in my first paragraph.

Conclusion: if you’re dealing with valuation, this could be a good resource. Valuation information is something like insurance account numbers: you don’t need it very often, but when you need it, you really need it. Like when you want to sell your company, or sell part of your company, or predict valuation as part of an investment negotiation, or when there’s a divorce, and … well, you get it.

Gripe: once they’ve published the data and put it out into the world as hard copy, can I get it online somewhere? Oh yeah, I get it, there’s value to the data. Tough call for BVR, how much do you give away to promote your data?

(Note: I posted this on Up and Running yesterday. I’m crossposting it here for reader’s convenience. – Tim)

I really don’t like the word “valuation”; it sounds too much like an MBA buzzword. But I like even less the general confusion about the concept. We talk about starting businesses, we talk about running businesses, getting investment, getting financed, and we should take discussion of valuation for granted. Valuation is at the same time frequently necessary, obvious and extremely arcane. It is nothing more than what a company is worth. It becomes necessary more often than you’d realize, with buy-sell agreements and tax implications after death and divorce, plus financing and investment. It’s obvious because a business is worth what a buyer will pay for it. And then it breaks down into complex formulas and negotiations.

So here are 10 (I hope simple) rules for valuation.

  1. Valuation is what a company is worth. It’s like what a house or a car is worth–less than the seller says, more than the buyer says.
  2. A company’s ownership is almost always divided into shares. Let’s say your company has 100 shares, 51 yours and 49 your co-owner’s.Valuation
  3. Valuation equals shares outstanding times the price of one share. If the company is worth $500,000 and there are 100 shares, then each share is worth $5,000. (OK, there are exceptions, preferred shares and such, but leave the fine tuning for later.)
  4. Tax authorities say the price of a share is whatever it was at the last transaction. (There, too, there are exceptions, but let’s keep this simple.)
  5. When startups offer shares–equity–to investors, then that, too, is simple math. If you sell 20 percent of the company for $100,000, that means the company is worth $500,000.
  6. Investment deals frequently revolve around valuation. When investors question your valuation, they’re saying they want more ownership for their money, or want to invest less money for their ownership.
  7. Analysts often apply formulas. The most common formula is called “times profits” because it multiplies profits times some number. Another common formula is “times sales.” Companies might be worth two times sales or 10 times profits. There’s also book value, which is assets less liabilities. And there’s the estimated sale value of assets.
  8. Privately held companies are worth less than publicly traded companies. They get discounted for the disadvantage of not being able to convert ownership to cash easily.
  9. Growing companies are worth more than stable or declining companies.
  10. As with real estate, comparable sales matter. Analysts look for recent transactions involving similar businesses.

Tim-Berry-Mixergy-Interview-2I thoroughly enjoyed doing this Mixergy Interview, published this week, about how I bootstrapped Palo Alto Software from zero to about $10 million annual revenues:

It started one morning at 2 a.m., when I had to deliver a finished set of financials the next morning. It was 2 a.m. and I was tired and done with the financials but I had done something in either Lotus 1, 2, 3 or Excel because I use both. I don’t remember which one it was but I had done something to break the damn spreadsheet! If the financials are going to work, when you change the assumptions the balance still balances and the cash flow, and so on.

So it was 2 a.m. and I had broken the spreadsheet. I thought to myself, there is so much productizability in this. I have to be [building this out,] assumptions, inputs, outputs [and so on], so that this doesn’t happen again.

Mixergy is a collection of interviews with entrepreneurs. Andrew Warner, founder, does a great job interviewing, and collecting interviews. The goal is a collection of thoughts and stories about entrepreneurship. I’m proud to be included.

Andrew posts the complete transcript along with the interview, so it’s easier to browse. Here’s another snippet, about raising venture capital and buying them back:

But then, and this is what’s important for the story, you need compatibility with your investors. When the whole thing crashed in 2001, then we had completely different business models. Our investors needed us to have an exit, a liquidity event. Valuations were back down onto what they really were, you know, two and a half times revenues, for example, for a healthy software company.

But two and a half times revenues wasn’t enough money to make me and my wife and our family feel like we wanted to just sell the business. I had to be 10 or 20 times revenues. But, our VCs were trapped as minority investors. And they were trapped forever. I now have eight angel investments. I understand how bad it is to be trapped as a minority investor with no hope of a liquidity event. I don’t want investors, even as a minority, who aren’t happy with me or my company, so we negotiated. Their lead partner there told me later that not until the negotiations were done, “Tim, actually I can tell you now, you are our best investment for 1999.”

Andrew led me through a lot of stories: How I failed as a hippy, how we got started on the web, how we realized we needed downloadable software, how I changed my role seven years ago to open the field for a new management team, and others.

I received this interesting detailed question from the ask me form on my website. I’ve decided to answer it here. I think my answer might be useful for others with similar questions. I’m putting the question in quotes, paragraph by paragraph, and adding my response directly where it comes in the question. 

It starts like this:

A person ‘X’ owns 15% stake in a startup company – not by investing money but purely by virtue of having dedicating hours for building a product for the company. No salary was to be paid as per an initial agreement. The 15% stake was deduced by a simple calculation: (value of company) / (number of hours worked) x (dollars per hour).

Was it clear in the initial agreement that the formula here was to be used in future buy-sell transactions? Was that agreed to by all?

The question continues:

The value of company is therefore, sum of [(number of hours worked) x (dollars per hour)] and [hard cash invested by a person 'Y', also taking into consideration year-on-year appreciation of this hard cash]. Lets call that VC.

No, it’s not. The value of the company is what somebody pays for it when they buy it. And if nobody is buying it, then the value of the company is an estimated value. There are lots of formulas for estimating it, and estimates will vary widely. I’ve got more on that below, in my specific recommendations.

However, it could be valued like you propose, for purposes of a buy-back transaction, if there was a buy-sell agreement that set that formula in the beginning. That’s if and only if. Issues like these are the reason experts recommend that partners and cofounders talk about the eventualities and agree, before the business starts, on how they’ll be handled. You have to agree beforehand or you’re stuck with arguing and negotiating the valuation afterwards. And when you try to pull it apart afterwards, without the benefit of an agreed-upono buy-sell formula, then many formulas might apply.

And here’s the heart of the question:

The company is not profitable yet. Person ‘X’ decides to give up his 15% stake of the company. My questions:

– How much is ‘X’ entitled to receive as the value for 15% stake?
– Calculating backward, would X receive as much as [(number of hours worked) x (dollars per hour)]?
– How does this change if the only buyers of the 15% stake are also two other stake-holders within this company, one of them by virtue of cash invested in the company, and the other by virtue of hours spent working for the company?

Normally, unless otherwise specified, owning 15 percent of a company means you own some shares that amounted to 15 percent of the total shares issued when they were issued. Ownership privileges are defined in company documents. You might have a seat on a board of directors, or not. You might get dividends when that’s relevant. And you’ll be able to sell those shares subject to securities and exchange regulations.

Just hypothetically, as an example, say you agreed two years ago that you got 15% because you had put $15,000 worth of work on it for free and the founders agreed then that it was worth $100,000. If it’s launched and very successful now, with sales of $1 million annually, then it’s worth something like one or two times revenues, less a discount for debts, less a discount for not being liquid. In that case your 15% is worth something like $100,000. On the other hand, if it launched, has no sales, no profits, and has spent all its money, then your 15% is worth about zero. Companies are almost never worth a formula based on hours worked.

So unless you have that buy-sell agreement stipulating the formula you’re using, then it doesn’t apply. Here’s what I recommend.

  1. Agree on an estimated valuation. The formula you’re suggesting seems like it might be one-sided and self-serving. Good luck with it because it’s going to be hard. Expect disagreements. Depending on how much money is at stake and how severe the disagreement, you might need to work with an attorney and a valuation expert you can agree on. Here are some posts on this blog about valuation. This one is particularly relevant: 5 things business owners need to know about valuation. Sales, sales growth, profitability, and scalability and defensibility make it worth more. Debt, and not being liquid shares, low growth, and losses make it worth less.
  2. Take 15% of that valuation and negotiate with your cofounders based on that value. I hope for your sake and the sake of your cofounders that things are going well for this business and they’re happy to buy you out. If they aren’t, then you’ll have to keep discounting until you get to an amount they’ll pay you. Or just keep your 15% of the shares, stop working for the company, and hope that someday they’ll be worth something.

The moral of the story: please, the vast majority of business marriages (partnerships, startups with founders, etc.) end in divorce. Do a business pre-nuptial agreement, which is what they call a buy-sell agreement.



Greatly appreciate your response and all your help!

Question: I own a business with my brother for the past 16 years. I decided to buy my partner/brother out of the business. The business has been running a loss for the past couple of years. How do we put a value on the business without incurring the expense of a Business Expert?

OK, stop immediately and rethink your question. Doing this deal “without incurring the expense of a business expert” is a really bad idea. The biggest danger in this deal isn’t paying too much or too little, but rather doing a deal that leaves either one of you thinking it was unfair. If ever there was a good place to spend some money on an expert, this is it.

Why? Because there are so many different ways to calculate fair value, with so many different results, that without a very good expert and full understanding as you do the deal, somebody is sure to question it later.

Start by thinking about the value of a house. Its value depends on many different factors, including size, condition, the land it’s on, the neighborhood, the needs of the owners, and changing market conditions such as interest rates and local economic factors. Valuing a business is like that but even more complex, because the underlying worth depends on future earnings, and both buyer and seller have to guess future earnings.

There are some simple standards to start with. Consider that large, publicly traded companies are worth some multiple of their annual earnings, traditionally 5 or 10 times earnings or so, but that depends on market conditions. The market values some high-tech growth companies at 50 times their earnings … that’s the play of market factors. Investors like these companies so their relative value goes up.

  • When you have a small, privately-owned company, the earnings multiples go way down. Generally buyers realize there is more risk in a small company than a big one. The increase in risk reduces the valuation.
  • Another frequently-used formula is based on sales. Your company might be worth as little as half its last year’s sales, as much as 2 or 3 times its last year’s sales, depending on the specifics of what industry, how much growth, how much future potential, etc. This is more important than the earnings-based formulas for you, of course, because you don’t have earnings. It’s quite common with high-tech companies. As with real estate, you can get data on other transactions by industry and size, which could help give you some idea of the latest trends. The formulas change quickly as market conditions change. And although the data is called “comparables,” just like in real estate, it’s a lot harder to interpret because so much depends on the specific case. Growth increases your value, decline decreases it, and there are lots of intangibles related to the future, such as location, intellectual property, etc.
  • There are lots of other formulas that might apply. Book value is assets less liabilities. Professionals might take book value and adjust for different factors.
  • To make this even more confusing, there are valuation experts certified by the IRS who will assign a value used to determine tax liabilities when companies change hands because of death of divorce. Their valuation can go very low; I know of one case in which a company worth several million dollars was certified worth only a few hundred thousand, for tax purposes, by a registered valuation expert whose verdict was accepted by the IRS.

So getting back to your question, I recommend you and your brother find somebody you can both trust, either an accountant or an attorney or maybe a consultant with great references — be more careful with consultants because there is much less regulation in consulting, therefore it’s harder to determine true professionalism — and go over all of the various formulas, together, and understand how they might yield different results.

Your goal should be getting on the same page, together, in a way that protects you against the danger of doing a deal and then, afterwards, having some new expert coming up with some logically sounding new formula that makes one or the other of you think the deal was unfair. The key to fairness is to base the transaction on a true market value, a real market value, one which will leave neither one of you vulnerable to some half-baked expert opinion after the fact.

Don’t get adversarial.  This should not be about negotiation.  Avoid having the two of you represented by two separate experts, each voicing a slanted point of view. Look for somebody you can charge with creating a fair deal, somebody who feels like he or she will be available for a pleasant lunch a year later, not taking sides. You should both be clients.

Keep in mind that the goal isn’t winning or losing the deal, it’s making this change fairly, so there are no losers, and probably (up to you) in a way that preserves the relationships.


(Rounding up my business planning theme this week, this is another excerpt from my book The Plan-As-You-Go Business Plan, which is posted complete online.)

Your plan-as-you-go business plan is no more than what you need to run your business. In the beginning, it might be as simple as an elevator speech. Be able to talk through those key points: the customer story, what makes you unique, how you’re focusing and on what you’re focusing, and, if it comes to that, your close — what you want from whoever is listening.

Or it might be a simple sales forecast, and perhaps, a burn rate in the very beginning because you know what you’re doing — maybe you’ve been doing it for years already and you don’t need to verbalize it right at this moment — and you’ll set those figures down and start tracking them

Planning comes in many forms. Think of it as analogous to motion in athletics. In so many different sports, the winners practice economy of motion, repeated muscle memory. Another way to look at it: in design and mechanics, the fewer moving parts, the better. If you have to squint conceptually to see the key points, squint down on the elements you’ll be able to track and then revisit.

It’s not about the text, or the form of the thing, until that becomes related to the function. When you’re doing a business plan as part of a graduate business school class, then yes, it has to be complete and look good and read well; editing and format matter. When you’re doing a plan for an investment group that is going to pass it around among the partners, then it matters. But you don’t want to get bogged down in format when it’s just you and your spouse and you simply want to think through what’s required.

So the plan is a collection of concepts in the middle, surrounded by specifics that have to be done. Around the core you put a collection of metrics to be measured and tracked (lots of them are sales, expenses, and the like, but not all), task assignments and responsibilities for different people, dates and deadlines, budgets, and so on. That’s your plan.

From that core plan, you spin off various outputs. You take the highest highlights of the plan and 60 seconds or so to explain it in an elevator speech. That’s one output. Or you write it all out carefully, and add supporting information about the market and the industry and the backgrounds of the management team, and it’s a plan document. Or you create a 20-minute 10-slide summary with PowerPoint or Keynote slides, and that’s a pitch presentation for potential investors. Or you create a cover letter or cover e-mail, about a page or so, along with a 5- to 10-page written summary, and that’s a summary memo. Or you do none of these, you simply keep that plan as a collection of bullet points, of picture financial projections, and a list of things to be done by whom and when and for how much money, and share it with your team. In that last case you don’t ever edit or polish it, or sweat the page headers and page footers or font size. You just use it to manage your company,

Notice that none of these outputs stands as something you do instead of the plan. And none of these outputs is really the plan. The plan exists at the core, and you create the outputs as needed.

With all of these various iterations and outputs, always keep assumptions on top, where you can see them for every review meeting. Minding the changing assumptions is one of the significant advantages of the plan-as-you-go approach over the more traditional methods.

I ran a business for years during which the plan was shared only between me and my wife, mostly, enhanced by sales forecasts and burn rate. During those formative years there was no need for anything else. When it was time for an elevator speech, either one of us could do it. When there was need for a written business plan — it came up first when we first set up the merchant account to be able to accept credit cards, in 1988 — then we settled down for a while and wrote it out as it was, conceptually, at that time. We always knew what we wanted to do, but we also knew our key assumptions, and we tracked them as they changed, and revised the plan. A lot of that was verbal, between two people.

As the business grew, the verbal plan with the forecast stopped working. Things became more complicated. Employees needed to know about the plan and join in its formation and then its implementation. So we moved it into bullet points on the computer, and tied those to forecasts, and began tracking in a group, in more detail.

We then began to do annual plans more formally, writing out chapters, and conducting review meetings every month. With each annual plan we’d go out and take a new fresh look at the market. We had people doing nothing but marketing, and they developed segmentations and forecasts and supporting information. It was part of their job.

Are you recognizing yourself somewhere along this line?

Eventually we wanted to bring in outside investment. That was during the dotcom boom when valuations were very high, so we thought it would be a good time to lock in the value with some cash out. We produced very formal plans every three months during that period.

The speech isn’t instead of the plan, and the pitch isn’t instead of the plan, but that doesn’t mean you plan or don’t plan if nobody outside your company is going to read about it. Your plan should always be there as the source of these outputs, so you’re ready to produce them when you need to.