In this article we’ll discuss what it takes to be a business worth investing in. When we ask the question “what makes a business worth investing in?”, what we’re really asking is “how do you value a company?”
This is quite a large topic. Predators want to value a company before they take over a target, and it’s something that investors should have an interest in when buying shares. If you’re buying a share you want to be able to look at a company and evaluate whether or not you’re getting good value for money.
When we dig even deeper, this question becomes how do we evaluate the value of any asset? For example, there are three ways to evaluate a house. A bottom up estimation of what it would cost to buy the land and build it. The price of houses nearby. Or you could say the property is only worth what the market is prepared to pay. Companies can be valued using a similar three-pronged approach.
Fundamentally, determining a worthy investment in a business is more art than science.
Let’s look at it from the buyer’s perspective. The first approach is known as the asset-based approached. For this, you could take a company’s balance sheet, look at the list of assets, make some adjustments and analyse it like a buyer to come up with an asset based evaluation.
So do you just stop there? No. The chances are you’re not buying the company to simply flog off the assets. You’re more likely to be buying it, for example, as a predator or investor, with a view to the longer term. You’re looking at what you can squeeze out of it.
The second approach would be the house next door approach. This is also known as the ratio based approach. For this example, let’s take similar companies such as the company which your company operates in, and look at a metric like their PE ratio, or their price to sales ratio, to see if we can come up with a comparative number.
The third approach is called discounted cash flow (DCF). This is akin to looking at what a property’s worth based on its rental income in the future. With this we can forecast the earnings and cash flow that a company will generate looking into the future, and bring it back into today’s money using a discount rate.
So knowing that investors will have these three basic approaches in mind, how do you get them interested in your business?
The key to getting an investor’s interest in your business is to have an excellent business plan.
The first thing you need is to have your executive summary of your business which can be just a few pages on what it is that you do. Make sure this is easy to read or your business plan will go straight into the bin. If they don’t see the opportunity in your business that make it worth investing in then you have no chance, so make it your business plan so easy to understand that your grandma could understand it. Investors do not know your business as well as you do, so make it very simple.
The next thing an investor will look at is your management team. The idea is important, but the team that executes this idea is even more important. You want to show that your management team has experience and competency. A lack of experience in the management team is often the biggest factor that holds companies back from receiving investment. Make sure your management bios look great, showing off all the wins that you’ve had. Your management team should complement your weaknesses and show investors that you’ve thought this through.
The final thing an investor may look at is financials at the end of your plan. Do your numbers make sense? Is there opportunity for them to make money? Ensure your projections are realistic, don’t aim to be the next Microsoft in just three years. Your use of proceeds must also make sense. Make it clear how the investor can get a return on investment.
If you’re interested in investing, just choose the right platform like CMC Markets and give it a spin.