Have you ever wondered what the difference between your company’s value vs the value of its shares is? Where does the actual value of the company lie, the one that can help set a selling price? It’s important not to confuse the company’s value with the value of shares.
When creating a company, we pour all our blood, sweat and tears into making agreat idea a reality. Although human and commonplace, this idea can lead to misconceptions regarding establishing the company’s value.
Unfortunately, our feelings about the company do not affect its real value when we present it to a potential buyer. If we are considering selling, buyers, after all, assess technical aspects and apply valuation methodologies to analyse the company and determine its value objectively.
Value is a matter of perspective, which means that it will vary depending on the point of view from which you look at it, especially when comparing the value of the company versus the value of the shares. When you evaluate your company, you are determining how much it is worth as a whole.
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It is essential to remember that value is subjective; in the case of M&A, it is the range of what a company may be worth. Various valuation methods help us reduce the margin of error in determining the actual value of a company.
It should be noted that establishing the actual value of something is extremely difficult because the methodologies used to value a company only provide a range of value. This range of value serves as a guide to determine the correct price of the company and will vary depending on the valuation method.
We have often seen entrepreneurs confuse value with turnover, price and even share value.
If you want to know which methods can be used to analyse the value range, read our article Benefits of the valuation football field.
In accounting, turnover determines the direction of a company’s operations, i.e. how quickly it sells its stock, but profit does not necessarily equate to high value. One thing a potential investor or buyer would look at is debt, which diminishes the value of the company.
We had a client whose business was an electronics company. His suppliers were in China, so he paid for goods 90 days before receiving the stock. Once they arrived, he sold to a large retailer, who paid him in 120 days. As a result, he had to finance 210 days of stock.
They had a turnover of 30 million euros and only made 200,000 euros, before tax. Such long periods between buying and receiving stock resulted in tiny profit margins and a very low-value business model. The company needed discount lines to finance inventory and growth. This accumulated 14 million euros of debt with banks and paying high-interest rates.
They asked for help to sell the company, convinced that, with a turnover of 30 million euros, their company would be worth a lot. No matter how much we explained to them that turnover does not translate into value, they would not listen. It wasn’t until they started receiving offers that they finally understood the reality of their company’s value.
Significantly few investors were interested in buying a company that generated little profit, had accumulated so much debt and posed such a significant risk of bankruptcy.
Debt burdens companies with low-profit margins and long periods before receiving profits. The owner makes a minimal profit by removing any debt from the transaction price to calculate the shareholder price.
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It is essential not to confuse the company’s value with the value of shares. Whatever the value of a company’s shares is, it does not affect the value of the company. The value of the shares results from the company’s value minus its debt.
When valuing the company, we subtract the net financial debt from the value of the company. All financing that currently pays interest is financial debt. If the shareholders have put up 60% of the money and the financial creditors 40%, the value of the shares will be only 60% of the company’s value.
This is why the shares of some companies may have a negative value. If a company that is worth 10 million euros has 12 million euros of financial debt, then it has a negative value of two million euros.
Confusing company value and value of shares in the event of a sale
In the event of a sale, shareholders would receive nothing. The company would be purchased for one euro, while creditors would have to deduct two million euros from their debt. Otherwise, no sensible person would take over the company because they would buy it for less than its value.
Sometimes the opposite can happen. The shares of some companies can be vital because they have no debt, which increases their value.
When selling a company, to calculate the value of the shares, subtract the net financial debt from the company’s total value. In other terms, subtract the company’s debt and then add the cash on hand.
To get an idea, imagine you sell your house for 500,000 euros and have a mortgage of 300,000 euros. After the sale, you will receive only 200,000 euros.
However, remember that debt does not necessarily mean having the wrong financial structure. Financing can be a powerful tool to boost your business and, consequently, your company’s value.
Let’s say your company has a turnover of 30 million euros but has accumulated a debt of 4.5 million euros. You make an investment of 4.5 million in short- and long-term projects. This includes the purchase of machinery, the construction of better structures, and the renovation of the business.
The business will likely improve in the future thanks to the financing. However, you should ensure you understand that any accumulated debt will reduce your business’s value.
As we have seen, in the beginning, the company´s value and the value of shares are easily confused, as it can be believed that they are the same.
When we no longer confuse a company´s value and company shares, we can distinguish what weight to give them in the company’s valuation. In short, the value of a company is the value of the sum of its parts, and the value of the shares is the result of the value of the company minus the company’s debt.
ONEtoONE Corporate Finance has offices in Europe, the United States, Latin America, Asia and Oceania. We are a global advisory firm specialising in selling companies like yours. All our human and technological resources, databases, experience and processes are focused on helping our clients sell their companies at the highest possible price. We help you strengthen your legacy, so you can focus on what matters to you in this new stage of your life.
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