Business Valuations – some BIG Fallacies

So you are thinking about selling your business... what is the first step. Most business owners want to know what they can expect to receive from the sale of their businesses. Some owners have a pretty good idea of the value of their company while others don’t have a clue.

In either case, the business owner requests a valuation expert (or appropriate service provider) to prepare a valuation on his business. In most cases, the business owner neither knows what to expect in the requested document nor how much it will cost. Valuations can range from a “no charge” back-of-the-envelope valuation to an 80 page tome at a cost of $20,000. Why the big spread and what type/cost of valuation is best for you?

The “slick” valuations are generally prepared by professionals with lots of initials after their name, and the presentations are suitable for coffee tables. At the other end of the spectrum, the low cost (or no cost) valuations are very informal, often running just a couple of pages in length. The preparer of the second genre of valuations is often a business broker who has no initials after his name.

In deciding whether to go with one extreme or the other (or of course something in between), you should know (a) something about the valuation expert’s on the ground experience; and (b) what criteria is being used in the valuation.

I have asked many so called valuation experts “how many business sales have you been involved in,” and the answer is often a very low number. The obvious follow-up question is how can you know the value of a business unless you are out on the street regularly doing business sales? Theory is great for graduate business students, but current demand and market conditions are the real drivers of sales price. Many valuation experts might be great testifying in a divorce trial about the value of a business, but they have no sense of the real value of the business; i.e. what it will sell for to a ready and willing buyer.

In addition to having minimal street experience, many valuation experts embrace valuation components which frankly cause business buyers to laugh. No business buyer is interested in the seller’s five year business plan, or in a 10 year discounted cash flow, or in the probability of getting a giant, five year government contract. Simply put, business buyers will pay for what the seller’s business has accomplished (we call this “looking in the rear view mirror”). Business buyers will not pay for what the seller thinks could happen to the business under the buyer’s new ownership. There is not a business buyer on the planet who feels he should pay for what he, the buyer, accomplishes in the future so why should business valuations include such useless components?

At the end of the day, perhaps the back-of-the-envelope valuation from the guy who sells 10 business every year is a smart (and inexpensive) way to go.

Contributed by Michael Greengard, Praxis Business Brokers.