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SPIE Professional January 2010

Give Your Business Value

What is your business worth? What factors drive the valuation?

By Linda Smith

Even if your business is not trading in the public markets, you may need to determine an accurate and defendable value for your company for legal and tax purposes such as estate planning, impaired asset judgments, litigation support, or to resolve shareholder disputes. A valuation of your privately held technology company is also critical for strategic planning and for decisions and negotiations around capital financing, buying another business, or licensing intellectual property.

Most of all, if you want to sell or acquire a business, you want to know what it is worth.

Your specific purpose for the valuation will call for different standards of value and different methods to converge on a defendable valuation opinion. Whether you are buying, selling, or growing, it is helpful for all stakeholders to know what the business is worth and what factors are driving that value, be they macroeconomic, operational, or legal, or issues involved with taxation, capital markets, financing, or industry served.

Technology Businesses Special

Regardless of valuation purpose, technology businesses are special. They exhibit high market and technological uncertainty. Their products typically are used in larger systems rather than alone and exhibit network externalities.

Technology businesses are also special because they are part of a complex business ecosystem with lots of "coopetition." These businesses both cooperate with competitors and compete with strategic partners. Often, there is also one technology with many, many business opportunities and product possibilities.

Consider the Advanced Photo System (APS) that was introduced in 1996 by Canon, Minolta, Nikon, Fuji, and Kodak. The new system included a new film format, a new camera technology, and an advanced photofinishing technology. Consumers and suppliers had to adopt an entirely new system. Market risk was extremely high despite coopetition and was ultimately never mitigated. The unavailability of film and photofinishing facilities indirectly drove down the valuation of the camera businesses.

Similar examples today are photonics technology companies addressing HDTV and medical imaging markets. While adhering to industry and regulatory standards, they are not directly supplying HDTV content or reagents. As a result, their valuation is heavily dependent on their coopetition in the value chain to mitigate market risk alongside them.

This combination of unique characteristics of technology products makes valuation of technology companies challenging, but it certainly does not make it black magic.

'Rule of Thumb' Right for You?

Even though your business is privately held, published multiples, or price-to-earnings ratios, of publicly traded companies and industry sectors are often quoted as rules-of-thumb for valuation.

However, this rule-of-thumb analysis is plausible only if your business is very similar to the public companies analyzed with respect to the plethora of factors that affect the value of the public stock. The fact alone that your business is not public makes it extremely different.

Professional appraisers following the method known as "Guideline Public Company" would normally apply discounts greater than 30% because private company equity lacks marketability.

Other factors that can map to additional discounts for privately held companies:

  • Your company is small relative to the size of comparable companies
  • Your business would be harmed if you or another key employee left
  • Your company has a high concentration of customers or suppliers in a single industry or market, or you have only one main customer
  • Your company lacks diversification

Whatever professional methods or guidelines are used, determining appropriate multiples requires multi-layered analyses of the business and its marketplace to realize any correlation to the public market.

Which Standard of Value?

Two standards of value that are applicable to most technology companies are fair market value and investment value, and the purpose of the valuation, not the type of company, drives the standard of value. See table at right.

The term fair market value is used in many contexts, including loosely and inappropriately as the be-all, end-all, or enterprise value of a business. However, there is no such value in general terms.

For a business valuation, fair market value is the amount a willing buyer would pay a seller when neither party is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts about the business. It most closely represents the amount that a financial buyer (typically a private equity company or a venture capitalist with no operating or marketing synergies) would pay for your business, and it is often the standard of value used for tax and legal purposes.

Investment value, on the other hand, is the specific value of an investment to a particular investor/buyer or class of investors/buyers based on their individual requirements. In the context of an acquisition, the investment value most closely represents the amount that strategic buyers with operating and market synergies would pay for your business.

Strategic buyers differ from financial buyers in that they want to acquire your company not just for its future cash flows but for the incremental cash flows from their products that are sold because of your products' differentiation. Considering that technology products are typically not used alone, but in larger systems, your company's investment value with strategic buyers in your business ecosystem can significantly exceed your company's fair market value with financial buyers.

standard of value
The purpose of the valuation drives the standard of value.
Stand Out in the Crowd

An appraiser may also approach the valuation by reviewing published data for recent transactions involving mergers and acquisition (M&A).

Recent M&A data in many market sectors is laden with distressed sales. Forecasts of future cash flows that are based on recent historical industry averages are also weighed down.

However, if your business is not distressed, has growth market opportunity, or is competitively positioned to take market share, these distressed transactions are not a basis for your company's valuation.

Where does that leave you?

Such an overall distressed market climate can be a timely opportunity for a high-performing or high-potential business to shine above the scorched earth and realize a favorable valuation in acquisition. Climbing out of the bunker to sell or to divest a product line may be a profitable alternative regardless of peer market comparables.

Approximate discount rates
Approximate discount rates used with the DCF method to value technology companies and IP.

Who Will Decide Value?

Accounting, financial and legal advisers are critical in gathering the necessary information to perform an objective business valuation. Very few lawyers, accountants and CPAs, however, have the necessary expertise and credentials to value a business.

These professionals may also have fundamental conflicts of interest in providing business valuation services, especially if the CPA or lawyer provides audit, tax, or legal services for your business.

The Uniform Standards of Professional Appraisal Practice (USPAP) are the generally accepted standards for professional appraisal practice in North America and include ethics and competency rules to maintain public trust in the appraisal profession.

With respect to closely held technology companies, accounting and legal professionals often lack sources to deep and broad market knowledge and technology differentiation to make defendable and credible valuation opinions. This is important because a company's valuation is based on benchmarking recent industry transactions and/or pro forma financials from the perspective of a strategic buyer in the markets served.

Advanced Methods

Monte Carlo simulation is a well established method to simulate optical phenomena in design software models, raytracing, and tolerancing of optical systems.

Monte Carlo simulation, "Real Option," and other advanced mathematical methods are being applied more and more to financial modeling and valuation of high risk, intangible assets such as IP, R&D, and venture-capital-financed businesses.

Traditional Discounted Cash Flow (DCF) methods that employ a single discount rate, regardless of risk mitigation over time and static forecasts assuming absolute certainty with no option of abandonment, often yield valuations that not even the most risk-tolerant investor, product manager, or CEO would tackle. Yet, these high risk opportunities can offer enormous rewards.

Advanced methods such as Monte Carlo simulation give insight at critical decision points and better account for high-risk, high-reward intangibles in early stage financings, impaired asset judgments, and licensing transactions.

-Linda Smith

New Workshop On Valuation

Ceres founder Linda Smith will teach a new workshop at SPIE Photonics West on 26 January that will focus on business valuation methods applied to the strategies and processes that business leaders use in financing, selling, buying, and licensing of IP.

The course, Valuation of Closely Held Technology Companies, Product Lines and Intellectual Property, will use two case studies of photonics companies positioning themselves for maximum valuation in exiting and licensing.

Her financial valuation "bootcamp" is intended for entrepreneurs, product managers, and business owners.

For more information: spie.org/pwvalue.

Linda Smith 
Linda Smith of Ceres Technology AdvisorsLinda Smith, founder and principal at Ceres Technology Advisors, Inc. (cerescom.net), has 20 years experience in marketing, product management, and sales in the photonics industry. She received bachelor's degrees in optics and mathematics from University of Rochester and an MBA from Babson College. Smith is an associate member of the American Society of Appraisers. 

Have a question or comment about this article? Write to us at spieprofessional@spie.org.

DOI: 10.1117/2.4201001.03

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