Do you have the next Facebook, Groupon, or Google? Or do you have the next eToys or Webvan? Do you have a trophy real estate asset like South Coast Plaza or a broken down strip center out in San Bernardino?
Almost everyone who owns a company or an asset tends to be overly optimistic about its value. That’s just the nature of entrepreneurs. If entrepreneurs and business owners weren’t optimistic, they would be doing something else like being a lawyer or a doctor.
The way you find out what your business or asset is really worth is by testing what investors or buyers are willing to pay for it. That’s really all that matters because other than what someone else will pay for your business its value has no tangible meaning. It’s just a number, and you can’t spend it.
So how do you test what investors would pay for your business or asset without actually selling it? One way is to research what investors are paying for similar businesses or assets recently.
There are outside experts called appraisers who do this for a living, but you also can do it yourself if you don’t want to hire someone to do it. The hard part about appraising your business or asset is being honest with yourself about which other businesses are really comparable to yours.
Don’t allow your optimism to cloud your judgment.
First, you need to establish certain metrics by which to evaluate the value of your business or asset. For some assets like apartment buildings, this is fairly easy. Methods for evaluating apartments are well established. Most people agree that apartments should trade on the basis of a stabilized cap rate on net income. So all you need to do is figure out the stabilized net income and see what cap rates are being paid recently for similar quality apartments in your area.
For many traditional, old economy industrial, retail, and service businesses a similar approach to this will work because the metrics for valuing them have been established over time and most people agree on how to do it. Usually, the disagreement in valuing traditional businesses focuses not on how to value the business but on the details of the company’s balance sheet, net income, and cash flow.
In a frothy or distressed market, there may also be a disagreement about the multiple that is appropriate for a traditional business or asset, but even then the disagreement is usually within a fairly narrow range of values.
Technology businesses are much harder to value, especially businesses that are focusing on new markets and new technologies about which there is not enough operating history to understand the future earnings potential or the intellectual and intangible assets.
Often there is disagreement even about the metrics to use for valuing the business.
Back during the Internet bubble of the late 1990s many people thought “eyeballs” were a reasonable way to value a business. Today some people would say that we’re in a new bubble and “eyeballs” have been replaced with unique users, the network effect, viral rates, and data collection.
Since the Internet industry still is in its early stages, and many of these new business model such as Twitter, Facebook, an Groupon are even earlier in their development, the value of these types of businesses are much harder to determine.
For this reason, as an entrepreneur, you need to be even more careful and more diligent in being honest with yourself about what your business is really worth. It’s easy to fall into the trap of believing your technology business has a unique mousetrap that is enormously valuable and will change the world, but in most cases that is not true.
There are many more companies and founders of companies who failed to sell when they should have during past frothy markets in technology than companies and founders that sold their companies too cheap or too early. In a frothy market like we have now, sometimes the best way to know if your technology company is overvalued is if the people who want to buy it or invest in it seem to have no understanding of it but somehow love it anyway.
This is because investment manias and bubbles tend to attract the least sophisticated and most optimistically delusional investors in the later and final stages. After this dumb money has already flooded into the market, there is usually not anyone left to buy from them and the market begins to deflate. If you’ve heard of the “greater fool theory,” these unsophisticated, extremely optimistic investors are the classic greater fools.
So-called “retail” investors via IPOs are the biggest and most visible example of this dumb money. However, there are other smaller examples such as people with no understanding of technology who are eager to make angel and venture capital investments in or buy technology businesses.
I would say we already have some of these naïve angel and venture investments happening, but the IPOs are still in the very early stages. So the good news is that we may still have some more room for this bull market in technology to run for a while, but all companies are not created equal.
Even if the market for technology firms remains strong for a while, your company may fall behind or get crushed by a competitor or rapidly shifting technological changes. Ultimately, the best way to value your business may be the price at which it makes sense for you personally to walk away and do something else with your life. Only you can determine what that value is.