Why Isn't My Company Worth Five-Times Sales?

Below is a recent article I co-authored with Bob Burke from the Natural Products Consulting Institute that was published by Investors' Circle.  Click here to go to the original article.

Why Isn't My Company Worth 5 Times Sales?

By Michael Burgmaier and Bob Burke

Trying to bridge the gap between what you think your company is worth and what investors think can be difficult and frustrating. As a general rule, entrepreneurs overvalue their companies. Who wouldn’t? Entrepreneurs are optimistic– that’s one of the main reasons we like working with them. And investors who decide to deploy their capital in a company do so because they believe in the promise of the company as well, but there is one major difference between investors and entrepreneurs: Investors better understand the risks they are taking with their investment.

If every idea was great and every company deserved capital, then banks would be lining up. Equity capital exists because equity is high-risk capital, and returns data plays this out. In general, one in three venture capital investments end up in a complete loss, one-third get back about what was invested, so a fund must typically make all of their returns/profits on the remaining third. For a fund then to make a respectable (and expected) overall return, those “winners” need to provide outsized returns. Investors know these numbers and the risk-reward game with which they are engaged, so they must price (value) their investments anticipating that most will fail. When valuing companies then, they must take a portfolio theory approach, or their winners will never perform enough to cover the losers.

Typically, a professional investor will tell a company what the valuation and terms of a deal will be. They know the market. On the other hand, angel investors often ask entrepreneurs what the terms of a deal are (pricing/valuation) – unless the angels’ investment is large enough to dictate terms. Angels often get involved with higher-risk deals as well – often pre-institutional capital. And the numbers play this out as well. A 2008 SBA study showed that close to half of all angel investments end in complete capital loss; only 7% end in returns in excess of ten-times the original investment – most likely a number well below the percentage of the deals funded that projected such returns.

Each year, Bob Burke and I run two seminars and networking events called “Financing Your Consumer or Natural/Specialty Products Company;” the next seminar will be May 19 in San Francisco. At our seminar last November in Boston, an angel investor talked about how he prices deals – he prices anticipating losses. In fact, out of the ten deals he makes, he expects to lose all his money on seven, make one-times his money on the eighth, five times on the ninth and 12 times on the tenth. That equates to an average cash-on-cash return of 1.8x and a 13% IRR. Not great, but it beat the stock market….

Entrepreneurs need to understand that investors need to price in risk. To the extent that a company does not present the “ideal” situation on all business risk terms (team, IP protection, gross margin, legal, market, competition, future financing capability…) and stage (later-stage and profitable), these risks are assumed by the investor and must be priced into the deal.

To learn more, consider attending the May 19 seminar. We have a terrific line-up of content and speakers, including entrepreneurs Keith Belling, Founder & CEO, PopChips; Sheryl O’Loughlin, Co founder & Chief Mom, The Nest Collective; and investors/debt sources such as Keith Kohler, President, The K2 Group LLC; Susie Lee, Principal, TBL Capital; Bill Shen, Vice President, Encore Consumer Capital; Tom Simone, Angel Investor, Chairman Emeritus of United Natural Foods, President and CEO of Simone & Associates; and Andrew Whitman, Managing Partner, 2x Consumer Product Growth Partners.

Bob Burke and Mike Burgmaier lead popular seminars and networking events on “Financing Your Consumer or Natural/Specialty Products Company”, the next one being in San Francisco on May 19, 2011. Click here for more information.

Bob Burke is co-author of The Natural Products Field Manual and The Sales Manager’s Handbook. He is a consultant in the natural and specialty products industry since 1998 and former VP of Sales and Corporate Development at Stonyfield Farm. He has prepared numerous business plans, assisted in fund raising, advised clients on growth and exit strategies and has helped a number of companies reach a successful exit. He serves on the board of directors of Stonyfield Farm, EcoFish, Nutrabella, and American Halal. He has an MBA from Babson College. For more info, please see: www.NaturalConsulting.com www.NPCInstitute.com

Michael Burgmaier is an investment banker with Silverwood Partners where he leads M&A and private placement transactions in the consumer product space, a speaker/event organizer with Royal River Associates and former venture capital investor in the food & beverage/consumer products sectors, where he helped lead four deals in the space. He has raised capital for numerous companies, helped facilitate successful exits, written business plans, prepared fundraising materials, has served on boards of venture-backed companies and speaks frequently on this topic. He has an MBA from the Tuck School at Dartmouth. Contact at mburgmaier@silverwoodpartners.com.