One Year In: Learning from the Greats

LinkedIn recently reminded me that it’s my “One Year Work Anniversary” at Alderway, so I figured what better time to reflect on the lessons I’ve learned so far and distil some of the wisdom from my investing heroes - Charlie Munger, Howard Marks, Seth Klarman, and others - showing how their insights are shaping our daily work at Alderway.

First Principles

The first lesson is that in times of economic uncertainty, like now, timeless principles of risk management, patience, and discipline are more crucial than ever. Rather than chasing speculative, high-growth startups, we’ve chosen to focus on stable, profitable, later-stage businesses as the backbone of our strategy - a smarter path to strong returns.

Why Stability is Sexy

Charlie Munger famously taught that "The first rule of compounding: never interrupt it unnecessarily." 

In volatile times, investing in businesses with a proven track record offers just that - a chance for uninterrupted growth. At Alderway, we focus on later-stage businesses that have weathered the scaling storms, built solid customer bases, and reached sustainable profitability. For us, these businesses represent the sweet spot: dependable returns with reduced risk.

Profitability: A Foundation for Long-Term Value

As Seth Klarman wisely states, "Risk is not knowing what you're doing."

With later-stage businesses, the guesswork, while not eliminated, is significantly reduced. These companies have refined their operational models, discovered their Structural Advantage, and are generating reliable profits.

At Alderway, these types of businesses form the foundation of our strategy, as their strong cash flows and profitability not only mitigate risk but are essential to compounding returns.

Another hero of mine, Guy Spier often emphasises that steady cash flows can shield companies from market turbulence - this insight is directly aligned with our approach.

Clarity in Exit Strategies

Investing in later-stage companies also provides clearer, more reliable exit options. The late Sam Zell famously said, “Liquidity is king,” and at Alderway, we take that to heart.

We work with businesses that offer straightforward paths to profitable exits, whether through strategic acquisitions or sales to larger private equity firms. In today’s market, this kind of predictability is invaluable, ensuring both us and the entrepreneurs we partner with can convert our positions into tangible returns—without the long, uncertain wait associated with earlier-stage ventures.

Prioritising Capital Preservation

Howard Marks, known for his rigorous focus on risk management, teaches that in uncertain markets, preserving capital is key. 

At Alderway, we echo this sentiment, emphasising sustainability and resilience over risky expansion. This focus on capital preservation is especially critical in the current investment cycle, where protecting capital is as vital as seeking growth.

As Brent Beshore of Permanent Equity says, "Steady compounding beats chasing outsized gains."

Conclusion: Wisdom from the Greats, the Alderway Approach

 As I continue learning from the great investors I admire, I find myself incorporating their principles into Alderway’s strategy. Whether it's Munger’s emphasis on compounding, Klarman’s focus on understanding patience, discipline and resolve, or Marks’ philosophy of risk management, these insights drive our mission.

At Alderway, we believe that investing in de-risked, later-stage businesses isn’t just a safe play - it’s a strategy that compounds value and transforms patience into strong returns.

Lastly, I’m reminded of Vitaliy Katsenelson’s philosophy from his extraordinary book, “Soul in the Game”. Vitaliy does a beautiful job of describing how balance is essential. According to him, “A life with ‘soul in the game’ is one where your actions are driven by passion and purpose - not just by money or external success." 

At Alderway, we're not just investors – we're stewards of capital and partners in growth. By embracing the wisdom of investing greats and focusing on stable, profitable businesses, we're aiming to build a foundation for enduring success – with our soul in the game every step of the way.

What investing principles guide your decisions? Who are your investing heroes? Get in touch, I'd love to know.

How to Value a Business: A Guide for Entrepreneurs

Valuing a business accurately is critical for entrepreneurs and investors alike, especially when looking to sell, invest, seek investment, or plan for growth. This business valuation guide will help you understand the essentials and the valuation process as a whole.

At Alderway, we support retiring business owners and businesses in often undervalued and overlooked Backbone Sectors. Accurate business valuation aligns with our Partnership Capital approach, helping businesses unlock value and achieve remarkable returns.

Alderway's guide to valuing your business

What is Business Valuation?

Business Valuation refers to determining a company's economic value. It's essential for business owners, investors / potential buyers, and financial professionals to assess a business's worth and a fair market value for various purposes.

Why Valuation Matters

Accurate business valuation is crucial for decision-making, including selling or buying a business, raising capital, strategic planning, mergers and acquisitions, and understanding a company’s financial health.

The importance of business valuation is particularly relevant for SMEs in Backbone Sectors, which may be overlooked but possess large customer bases with significant growth and investment potential.

The Importance of Accurate Business Valuation

Accurate valuation supports informed decision-making, helping entrepreneurs and investors determine fair pricing, evaluate potential investments, and negotiate better deals for long term future growth.

Valuation is also vital for planning growth, securing funding, and attracting investors. It helps businesses demonstrate their worth and potential to stakeholders.

Understanding the true value of a business also allows for better risk management, ensuring that owners and investors are aware of the business's strengths and weaknesses.

Common Business Valuation Methods

There are a number of different valuation approaches. Understanding industry best practices will be important when obtaining a company valuation. Different industries have specific valuation techniques most relevant to their market dynamics, so it’s important for you to understand what method will work best for your business. 

Here are some examples of popular valuation methods:

EBITDA Multiple Valuation

The EBITDA multiple is a valuation method used to assess the value of a business by comparing its Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA).

This ratio helps to normalise differences in capital structure, taxation, and fixed assets across companies, providing a clearer comparison. It's widely used in financial analysis, particularly for evaluating the potential for mergers and acquisitions, and to gauge whether a company is overvalued or undervalued relative to its peers. This is the method Alderway uses.

Entry Valuation

Entry valuation determines the business's value at the point of acquisition or investment. This method focuses on initial cost and projected returns / future profits, making it particularly relevant for other private equity firms.

Discounted Cash Flow (DCF)

The Discounted Cash Flow method values a business based on its future cash flow projections, discounted to present value. This method will incorporate a cash flow analysis and is ideal for businesses with predictable and stable cash flows.

Asset Valuation

The Asset Valuation method calculates a business's value based on its tangible and intangible assets. It's often used for companies with significant physical assets.

Times Revenue Method

This method values a business by applying a multiple to its revenue. It's common in industries where revenue is a key indicator of value, such as technology or software companies.

Price to Earnings (P/E) Ratio

The P/E Ratio method values a business based on its earnings, using a ratio that compares the company’s stock price to its earnings per share. This method is widely used for publicly traded companies.

Comparable Analysis

Comparable Analysis values a business by comparing it to similar companies that have been sold recently. It's particularly useful in industries with clear market leaders and benchmarks.

Precedent Transaction Method

The Precedent Transaction Method analyses the prices paid for similar businesses in past transactions. This method helps establish a valuation based on real-world data and market trends.

When and Why to Seek Specialist Advice for Business Valuation

Business valuation is complex and influenced by factors such as market conditions, industry trends, and unique business characteristics. It will take into account intellectual property, tangible assets (and sometimes intangible assets) and financial statements.

Seeking specialist advice is important, especially for SMEs in Backbone Sectors because professional valuers and business brokers bring expertise, objectivity, and an understanding of industry-specific factors.

Alderway’s Partnership Capital approach supports businesses in conducting thorough and accurate valuations, helping them unlock value and achieve growth.

Why You Should Value Your Business 

There are a number of reasons you might be looking to value your business including:

Selling your business

Business valuation is one of the first and most important factors in the selling process. Getting a correct value for your business before you sell will be key for a sale price that is fair and that you're happy with. Alongside helping your buyers assess their investment, it will ensure you receive a fair price. 

Raising Capital

Much like selling, valuation is also key when you’re raising capital. As investors, we would need to understand the business's worth and your financial performance with a cash flow analysis to determine the appropriate investment level and terms. Ensuring your have a clear value will help in both seeking the right investor and making sure you reach a fair deal for all parties as quickly as possible.

Strategic Planning and Growth

You don’t need to wait until you’re thinking of selling or getting investment to seek valuation for your business. Ongoing business valuation is important for strategic planning and growth now. Obtaining a fair market value will provide insights into where value can be added or optimised within your business plan so that even if you’re only beginning to think about selling or raising capital, you have all the information you need to prepare and increase the value of your business when the time comes.

Mergers and Acquisitions

Another time it will be vital to get a valuation is when it comes to mergers and acquisitions. Accurately assessing both companies involved will be important when negotiating terms and ensuring a successful integration.

Overall, understanding and accurately determining business value is essential for entrepreneurs and investors. Key valuation methods and the importance of seeking professional advice are recommended for unlocking potential and achieving remarkable returns.

A Guide to EBITDA for SMEs

Understanding Financial Health and Securing Investment

In the world of small and medium-sized enterprises (SMEs), understanding financial health is crucial. One of the key metrics to grasp is EBITDA which stands for Earnings Before Interest, Taxes, Depreciation and Amortisation.

This guide will explain why EBITDA for small businesses is so important as a performance metric and how it can help you assess the growth potential in your business and secure financing.

At Alderway, we focus on empowering exceptional entrepreneurs in often overlooked Backbone Sectors. Understanding financial metrics like EBITDA is essential for these businesses to unlock value and achieve remarkable returns. Our Partnership Capital approach provides both financial insight and the capital needed to support growth.

What is EBITDA?

EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortisation. It measures a company’s overall financial performance and serves as an alternative to net income in some scenarios.

Investors often use EBITDA as a fair and broad way to assess the strength of a company and how well they manage day-to-day operations against competitors. By looking at the business finance and removing tax rates, interest and depreciation, investors are able to compare businesses in similar fields. It can also help business owners when making operating decisions and managing their operating costs.

Why is EBITDA Important for SMEs?

EBITDA offers a clear picture of operational profitability and company performance and includes both operating and non-operating income. It excludes the impact of capital structure, taxation, and non-cash items.

For SMEs, this standardised measure of profitability is crucial when presenting financial health and financial position to investors, banks, and other stakeholders. It can be key to securing funding and making informed business decisions.

How to Calculate EBITDA

The basic formula for calculating EBITDA is:

[{EBITDA} = Net Profit} +{Interest} +{Taxes} +{Depreciation} +{Amortization}]

So let’s break that down…

1. Start with Net Profit (the bottom line on the income statement).

2. Add back Interest (the cost of borrowing).

3. Add back Taxes (corporate tax obligations).

4. Add back Depreciation (costs associated with the wear and tear of tangible assets).

5. Add back Amortisation (costs related to intangible assets like patents).

A Practical Example

Imagine an SME with the following financials:

• Net Profit: £100,000

• Interest: £20,000

• Taxes: £30,000

• Depreciation: £15,000

• Amortisation: £10,000

  
  

Using the formula, the EBITDA = £175,000.

What is the Debt to EBITDA Ratio?

The Debt to EBITDA ratio measures a company's ability to pay off its debt. This ratio is calculated by dividing the company’s total debt by its EBITDA.

If there is a high ratio, it indicates a higher financial burden, suggesting the company may struggle to pay off its debts. This can concern banks and investors. And if there is a low ratio it suggests the company is less leveraged and has a stronger ability to manage and repay its debt.

For SMEs, this ratio is critical when seeking financing. Banks and investors will use it to assess the risk associated with lending to the company.

If the same SME as above has a total debt of £350,000, the Debt to EBITDA ratio would be:

[{Debt to EBITDA Ratio} = {£350,000}{£175,000} = 2.0.]

What is a High Debt to EBITDA ratio?

Usually a debt to EBITDA of 1.0-2.0 is considered fairly low. This does depend on the context and the business, but generally speaking this is fairly low. A debt to EBITDA ratio of anything above 4 is seen as fairly high.

At Alderway, we prefer businesses without a heavy debt ratio and would tend to steer clear of higher ratios higher than 3.0 when making business valuations.

Financial Analysis and the role of EBITDA

EBITDA serves as a key metric when analysing your financial data. It helps SMEs assess their operating performance without the distortions of financial and accounting decisions.

Understanding EBITDA can also aid in better cash flow management by providing a clear view of operating cash flow and operating expenses. This is vital for day-to-day business operations and long-term planning.

While EBITDA is useful, it’s important to understand how it compares to other financial metrics:

• Net Income includes interest, taxes, depreciation, and amortization.

• Gross Profit only considers the cost of goods sold.

  
  

EBITDA might be more useful when you want to focus purely on operational performance.

Why Understanding EBITDA Matters for SMEs Looking to Secure Financing

A strong EBITDA figure and a favourable Debt to EBITDA ratio can significantly enhance an SME’s attractiveness to lenders and investors.

Companies with solid EBITDA figures on their financial statements are often seen as more stable and less risky, making them more appealing to private equity investors like Alderway.

How To Improve Your EBITDA

To improve your EBITDA and Debt to EBITDA ratio:

• Implement cost-cutting strategies.

• Improve operational efficiency.

• Refinance high-interest debt.

  
  

The Key Takeaways

EBITDA is a crucial financial metric for SMEs looking over the balance sheet, particularly when it comes to securing financing and assessing financial health.

Regularly calculating and monitoring your EBITDA and Debt to EBITDA ratio can help you plan for growth and attract investment.