How to Maximize Your Company's Valuation

By William Knoke, President of Harvard Capital Group

I've always been amazed by the number of deals that go to bed without having realized their full valuation.  A maximized valuation allows you to realize the biggest price for the smallest slice.

At the Harvard Capital Group, we’ve read, written and advised on zillions of business plans.  Here are some of the most often overlooked secrets that your mother never told you.  Your company might score high marks on some of these items, but circle the ones where you’re weak and fix them.

Dream Team.  The ideal management is a well-rounded team of people who have been profiled in Business Week for successful mega-deals, have depth in your industry, and have worked together before as a team.  In all my years as an investment banker or investor, I have never seen such a management group.

But some get close.  If you study the high-valued IPOs, you will notice that the hotshot management fill-ins all came six months before the IPO.  In one deal, we even suggested that the founder move “up” to Chairman of the Board to open the seat for a new CEO.  Similar shuffling is sometimes recommended for the heads of engineering, marketing, and finance.  The challenge is how to integrate the new talent with the old.

The purpose of this exercise is to maximize valuation.  It helps if you can attract the talent light on cash and heavy on stock grants or options.  It offers the promise of becoming a millionaire to key employees, and incoming investors love it because it leverages their dollar investment, and ensures that the recruits are true believers.

If you are short on cash, another option is to list high-octane “employees” waiting in the wings, pending funding.  That way you get their benefit for valuation purposes, but don’t spend any pre-money nickels.

Board Seats.  In forming your management team, many companies take the lazy-man approach to their Board of Directors.  Don’t.  For best valuation, you want a majority of board members to be outside members to keep the company honest.  If you are a good negotiator with stock options, you might be able to attract some well-known luminaries without cash, and build on their reputations to benefit your own valuation.

Sometimes talent is not willing to risk the liability of board membership, or the potential talent pool is too large a group to allow a Board to function properly.  Creating a Board of Advisors packed with well-respected names can solve this.  Such boards come in handy in high-tech environments, where the board is there as a resource to advise on cutting-edge issues.  Investors love it.

Clever Affiliations.  Part of the concept in both the Dream Team and the Board Seats, is to build value by affiliation.  The theory is that if you keep good company, you will get access to well-formed ideas.  The same concept can be extended to contract, outsourcing, and joint venture, even test site, deals.  When possible, affiliate with companies known for quality and reputation.  A little of their value will rub off on you… and so will the valuation.

Solve a Problem.  Of course, the best employees and affiliations in the world are worthless without a great product or service to concentrate everyone’s mind.  Whatever the product or service, it must solve some human problem that is not solved better elsewhere.  Too often, I’ve seen well-meaning engineers sporting a “product” with glitzy technology, but worthless for solving any real-world problems.  You need to start with a pressing human problem, show why your product is the best way on earth to solve it, and that your price is in proportion to the value-added to the customer.  The better job you do, the better your valuation.

Know Your Competitors.  In order to show that your solution is the best, you also have to expose the failings of competitive solutions.  Who are the competitors?  Why is our product better?  How big is the market?  Even better, is there anything about the competitors that structurally will give them a handicap?    (For example, in online retailing, how can the “brick and mortar” culture of Barnes and Noble compete with the “Nintendo” culture of Amazon.com?).

Spiffy Testimonials.  If you have customers, showcase them.  It helps to put a face on real-world problems solved for real people who write checks.  If you can’t disclose the identities of the customers for confidentiality reasons, describe them generically.  Is there a backlog?  Is there expressed interest for the future product line under development?

Intellectual Property.  During the Industrial Revolution, if you owned the factory, you generally owned the company.  In today’s world, wealth comes not from the physical plant, but from ideas and knowledge, and how they are deployed.  The problem is that knowledge, unlike the building, is mobile and easy to copy.  To maximize valuation, you need to anchor down the intellectual property.  This is done with patents, trade secrets, and non-compete clauses with employees, perhaps even key suppliers.  You have to nail these down.

Interestingly, in some high-tech valuations (read “Internet) it is not intellectual property, but first-mover status that anchors the valuation.  The theory is that by being first, the company becomes the largest, attracts more customers, becomes the most robust, and remains the largest.  Investors like that.

Wide and Deep.  In general, investors do not want to see a one-product company, especially in an age where technology makes products go obsolete like yesterday’s bananas.  They want to see a whole family of products for today and beyond.  But investors also want each product to be robust.  Catch 22: how can you be both wide and deep on a shoestring?

I’ve seen too many companies with four products going on five, each just 60% complete – worthless if they expect to sell anything.  Better to focus on your best product, and forget the rest.  Get customers, get backorders, and get testimonials.  The other products have a place, but only after first products get out the door.  (Of course, some situations require the whole family of products or nothing.  In that case, the first product is the family.)

Be Honest.   Unlike selling a second-hand car, a company’s valuation is best maximized with honest disclosures.  Big-dollar deals always have due diligence that will unmask any secrets.  Anything discovered that was not disclosed in advance will shake investor confidence.  “What else are they not telling me?”  Expect a huge valuation discount if you fail to disclose… and that assumes the investor even stays in the room.

It’s better to be upfront.  No deal is perfect.  I like to even turn disadvantages into advantages.  For example, “we know we have Defect X, but the incoming capital will allow us to hire this person, or pursue that acquisition to plug the void.”  Your candor will attract more money than you asked for.

Financial Stuff.  It’s the boring part, but it drives valuations… and kills deals.  For big-ticket deals with established companies, the best valuations go to companies having everything audited going back three or more years.  It removes the risk.  For high-tech startups, nobody cares about history as the valuation is based on the future.

When you do your projections, go out five years, and then cut it back to three and compare them.  If the three-year projection is almost as good, just show the three years, otherwise five.  Unless you are building a hydroelectric dam, you generally should not go beyond five years.  It is beyond the natural planning cycle of most projects, and you lose credibility.

Smart investors do not take projections seriously.  I use them to see if management has its thinking cap on.  Did they take everything into account?  Are the assumptions reasonable?  Does it dovetail with the other aspects of the plan, the products, personnel and financial resources?

One red flag is when projections contain too many numbers with trailing zeros.  It shows the numbers are simple-minded and not resulting from the confluence of multiple assumptions.  In my office, too many zeros add up to a zero deal valuation.  Such projections are appropriate only on a restaurant napkin.

Deal Structure.  Depending on your personal goals, sometimes deal structure can be traded off against a higher valuation.  For example, issuing well-crafted Convertible Preferred Stock may allow you to give up a smaller percentage of the company for the same amount of money.  In exchange for that, the Preferred stockholders have certain privileges, such as, say, appointing a few board members or taking control of the company if the grapes sour.  In a way, it is trading off power for valuation.  Properly done, both sides can end up with a better deal, and the valuation zooms.

Business Plan.   There is no one standard outline for a business plan.  Each has to be tailored to the extraordinary qualities of each company.  However, for maximum valuation, any plan should be up-to-date (otherwise the deal looks shopped), focused on the deal at hand (to exploit each nuance of the company relevant to the deal), and targeted to a specific, narrow audience (CEOs think differently from, say, VCs).  For most private transactions, I rather prefer a format based on the SEC’s Form S-1 (or Form SB-2), so that sophisticated investors know where to find what intuitively.  But for private transactions, this format needs to be considerably beefed up, especially in the areas of product advantages, competition, customers, operations and future prospects.  For the best valuation, all the key decision information has to be there.  People will not buy what they cannot understand.  And people will value highest that which is precious.