Thinking about the value of your company, 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 we create a company, almost always starting from scratch, we pour all our energy, blood, sweat and tears into it to make the great idea we always knew would be 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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What do we mean when we say that enterprise value is a matter of perspective?
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. This is measured using various valuation methods that help us to 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.
Turnover does not equal value
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, accumulating 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 willing or interested in buying a company that generated little profit, had accumulated so much debt and posed such a significant risk of bankruptcy.
Companies with low-profit margins and long periods before receiving profits are burdened with debt. The owner makes a minimal profit by removing any debt from the transaction price to calculate the shareholder price.
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Company value vs. share value
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 but the other way around. The value of the shares results from the company’s value minus its debt.
When valuing the company, the net financial debt is subtracted 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. For example, a company that is worth 10 million euros, but has 12 million euros of financial debt, has a negative value of two million euros.
In the event of a sale, the shareholders would receive nothing, the company would be bought for one euro, and the 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 find out how much the shares are worth, subtract the net financial debt from the company’s total value, i.e. 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. When you get paid after the sale, you will only receive 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. 4.5 million is invested in short- and long-term projects, such as buying machinery, building better structures and renovating 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 be subtracted from the value of your business.
Different but valuable
As we have seen, in the beginning, it’s easy to confuse company’s value with the value of the shares, as it can be believed that they are the same.
When we understand the relationship between the two concepts, we can really distinguish the difference and what weight to give to each of 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.
Are you ready to sell? It’s your time, and we’re here to help!