By Shannon Katureebe
There is a popular saying in Kampala “If you want to kill a friendship, start a business with your best friend.” If it fails, the friendship can suffer a silent death. However, if it succeeds the friendship becomes stronger.
Before investing in a friend’s business or being funded by an investor if you are the business owner, can you accurately value the business?
Can you determine the value of your/their capital in the business? Are you able to share profits fairly with each getting what they deserve?
When co-founders or business partners have answered or agreed on these questions, the business can enjoy uninterrupted growth and become insulated from threats such as ego issues and unresolved grudges. These small things are the heartbeat of a small business owned by more than one person.it is very dangerous to ignore these issues or deal with them unprofessionally!
Generally speaking, there are 3 ways to value a business;
Asset based approach
This requires that you add up the current value of everything the company owns. This also includes valuing yourself (in terms of salaries you would be getting at any regular job) plus any copyrights, patents, exclusive rights and physical property. The other aspect to consider is relationship with customers or data about them.
Market based valuation.
This requires that you estimate the size of your addressable market. That means you have to be realistic in terms of how many people and what they will pay. Then you take other businesses into account and settle on a realistic figure slightly above average.
Income based approach
This requires projections of cash flows from customers. You use these cash flows, plugging them into a discounted cash flow spreadsheet (available in Google sheets). This gives you a single number called a Net Present Value, which takes both risk and growth into account. This is a starting point for you and friends to discuss what sort of factors will affect the initial value.
You should be familiar with all the three and be able to use each of them to discuss the fundamentals of your business with a benefactor or beneficiary depending on which side of the coin you are in the transaction. The more perspectives you have considered, the stronger your argument will be.
Once you agree on a value for the company and amount of investment, you can start calculating the rest of the important numbers. Having done that, there are two important outcomes to note i.e. Pre Money valuation and Post money valuation.
Pre Money valuation
This is the value of your company before you receive private investment. You will arrive at this figure by using the approaches described.
Post Money valuation
This is the value of your company after you receive private investment. You will arrive at this figure by adding together your pre money valuation and amount of private investment. This is the total that you use to calculate the percentage of equity to give the benefactor.
For example; if you and your benefactor negotiated the pre money value of your company at sh15million and he or she gave you sh.5million as equity, then your post money value would be sh20million. To calculate his or her equity percentage, you divide sh5million by sh20million multiplied by 100; arriving at 25%. Therefore profits will be shared in a ratio of (75:25) %.
Do not be manipulated or cheated because of your urgent need of private investment.
These valuations and mathematics apply to all businesses whether very small or very big, starting or existing, informal or formal. Knowledge is Power!