Challenges Entrepreneurs Face in the Valuation of their Businesses

I listened to one of the episodes in Season 2 of the Lion’s Den, Kenya’s own edition of ‘Shark Tank’ that airs every Monday being an initiative of Kenya Commercial Bank (KCB). It was my first time to watch the show.

On the panel of investors were Kris Senanu who is the Managing Director for Telkom Kenya’s Enterprise Division, Wandia Gichuru, the Managing Director at Vivo Active Wear, Darshan Chandaria, the CEO Chandaria Industries, Myke Rabar, the CEO of Homeboyz and Olive Gachara who is an entrepreneur in fashion and publishing industry.

https://www.youtube.com/watch?v=KugJ5GW30Jk

As the panel started receiving submissions from entrepreneurs who were pitching for the funding of their businesses, one thing came out clear: Entrepreneurs don’t know how to value their businesses. At one point, one of the investors had to put it blatantly clear, “Your valuation is ridiculous.” Most entrepreneurs on the show seemed not understand what valuation is and how it works. Majority of them were caught off-guard. Some gave conflicting numbers that they could not substantiate and some simply did not know what to say about the valuation of their businesses.

Someone said that numbers don’t lie but people lie about numbers. Many entrepreneurs, while pitching for potential clients and investors, think that by quoting ‘crazy’ valuations of their businesses and companies will attract clients and investors to them. This is a misplaced notion that is hurting many startups as most of them have ended up missing opportunities to have someone invest in their businesses because of telling ‘lies’ about the valuation of their companies and businesses. Valuation of a company or business requires openness, truth, and facts because if one is giving numbers that cannot be substantiated, the truth will just come out.

Entrepreneurs don’t know what investors base on when they ask for the valuation of the business or company. There are two aspects that they mostly base on. These are income valuation and market valuation.

Income valuation is also known as income forecast. Entrepreneurs are not aware that this approach has limitations and should not just be given for the sake of funding. Most young companies have a limited past record of earning and it is, therefore, challenging to forecast the accuracy of the income stream. Your valuation is based on matching your forecast with reality.

The market valuation is about comparable companies. This is about looking at other similar companies and businesses, what they offer, the competition they bring to your business and company among other things. For startups, however, it is not easy to compare with other players in other markets. All in all, valuation is necessary for granting value stock options to employees, comply with tax and financial reporting requirements, and attract investment, in the acquisition or IPO Scenarios.

There are some Dos and Don’ts while thinking of valuing your business or company. The silent rule is, do not tell lies. Give the numbers as they are. Here are some of the techniques:

1. Asset Valuation

This about adding shilling values on all the asset the company or the business has, placing on the company’s balance sheet and then summing them up. The best way to value assets in your company is to start with physical assets such as machinery, furniture, computers among others and put a cost on them. Others that must be included in the assets are intellectual property that includes such things as patents, trademarks and incorporation papers.

2. Market Valuation

This is estimating the company’s earning potential based on the theoretical demand for the same in the market. First, estimate the size and the growth of your target market. Your projections to grow should be based on how big or small the market is. When the market is big, your projection should be high and when it is small, your projection should be limited.

3. Income Valuation

This is about projecting the future cash flow of your business or company and discounting, at some rate, to arrive at their value in present shillings for instance.

I think having initiatives like the KCB’s Lion’s Den is the best way not only in empowering young upcoming and established entrepreneurs but also help enlighten entrepreneurs on what it takes to be in business.