Start Up Blog

2 schools of business valuation

Posted in entrepreneurship by Steve Sammartino on October 10, 2009

A favourite game of entrepreneurs, especially in the technology industry is discussing whether companies are worth the price they are bought out for. $1.5 billionĀ  for Youtube ………. Sales prices with infinite price earnings multiples (because there are no earnings, or they are loss making). Versus a company being sold for a few times it’s annual earnings with a long period of earnings history.

A more relevant discussion would be which school of business valuation was used during the transaction, and there are two:

1. Sale price representing believed potential

2. Sale price representing return on investment reality

Which is more valid? Well it depends on which side of the equation you are residing. I’d say when selling, we should be aiming for potential. When buying we should go with reality. When buying a business the simplest question to ask ourselves is this:

On current earnings, how many years will it take me to get back my original investment.

web media poster

There’s no doubt certain industries are more likely to sell using the potential valuation method. Burgeoning industries like the internet, IPO’s and even railways 200 years ago are good examples. To get away with selling on ‘potential’ the industry needs to be growing, the future unknown and your company well known. If your startup ever gets enough traction to sell to an incumbent, then take what you can get – sell on potential.

twitter-follow-me

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 1,227 other followers