How to determine value of a business

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

07 November 2021

An inspiring story appeared in the Daily Nation this week. It was about three young university graduates who started an organic fertiliser business with Sh50,000 and it has grown to be worth Sh150 million in just over six years. When I read that report, I wondered how this figure was arrived at. Was it the value of the assets of the business, or its net worth or its market value?

The only asset mentioned in the story is the land on which the business is located: it was purchased for Sh2 million about three years ago. The cost of machinery and equipment is not revealed – perhaps because it has less value than the land! It is difficult to visualise how these raise the business value to Sh150 million.

Furthermore, if the assets of the business are worth less than Sh150M, there is no way its net worth (assets minus liabilities) can be Sh150M! Perhaps the owners are referring to the market value of the company. This is very difficult to establish for it depends on what a third-party investor would offer for a stake in it.

However, there are some indicators that an investor might use as a guide. The most common is profitability. The question is: how long would it take to recoup the money invested?

The story does not reveal the profits of the business, only the sales. It is reported that “in a good month, we make sales worth Sh1 million”. I must emphasise that these are sales, not profits. We may guess that in a low season, the monthly sales are probably half that figure – Sh500,000. So, the average is about Sh750,000, which is Sh9M annually.

If we assume a 30 per cent profit margin on sales, it turns out that the annual profit of this business might be about Sh2.7M (about Sh225,000 monthly). An investor looking for, say, a ten-year payback period would offer about Sh27M for the entire business. Perhaps up to Sh50M when growth prospects are factored in. But, Sh150M is a very long stretch!

In 2007, Microsoft bought 1.6 per cent of Facebook for $240 million. That valued Facebook at $15 billion at a time when its sales revenues were just $150 million – and it was making losses! At that time, Microsoft wasn’t looking at the profitability but at the growth prospects; and they weren’t wrong! What is the growth potential of the organic fertiliser business?