When it comes to valuing a business, many entrepreneurs fall into common pitfalls that can lead to inaccurate or disappointing results. In this blog, we’ll explore the seven deadly sins of business valuation, shedding light on crucial mistakes that can hinder your understanding of your company’s true worth. From overestimating the value based on years of operation to misapplying multiples and undervaluing intangible assets, these missteps can have significant consequences when it comes time to sell.
By recognising and avoiding these mistakes, you can ensure a more accurate valuation and make informed decisions about your business’s future. So, let’s dive in and uncover the key factors to consider for a successful business valuation process.
- Mistake: You think your business is worth what you need to retire.
The problem is that it does not matter at all to the buyer. The buyer only wants to investigate what future maintainable earnings are there into the future or what value there is in the assets.
- Delusion: You think your business is worth a lot of money because you have had it for 20 years.
Unfortunately, it doesn’t matter how long you’ve run your business. It’s the value proposition that you’re offering to the buyer that matters. You could have a business that you ran for 20 years and it could be worth nothing or you could have just started up a business and it could be worth millions. Business owners think that because they put 20 years into their business they deserve to be rewarded. Sorry, no one cares how long you’ve been in the business Boost its value by recognisable and identifiable means or just put up with the poor valuation report you will receive from a broker/valuer who is honest with you.
- Error in Multiple of Profit Figure: Accountants and business owners apply the wrong multiple to the wrong profit figure. There are generally accepted ranges of multiples that are applied to particular profit classes. One such multiple, called an EBIT multiple will be smaller than another class called EBITDA for the same business. (Refer to our website glossary of terms for what these acronyms mean) Hence you would need to apply a smaller multiple to an EBIT than to an EBITDA. You would be surprised to learn how many so-called experts apply the wrong multiple to the profit figure.
- Methodology: You should not value goodwill separately.
Goodwill is defined as the residual value in a business that is left after the total value has had deducted from it the assets. That is:
total value = assets + goodwill.
If you make the mistake of valuing goodwill separately and then adding the assets you will more often than not overvalue the business. This is a common mistake made at the small business level.
- False Equivalence: Business owners think their business is worth the same to a buyer as it is to them. The mistake they making here is not taking into account the risk of the transaction. The risk of the transaction can be the risk of losing 10% of the clients or 90% of the clients, depending on the relationship that the business owner has with the clients. There are many other risks of the transaction including loss of key staff, degrading of relationships with key suppliers and other risks inherent in a new boss moving into the Managing Director’s office. The key is to take steps to remove the risk from the transaction.
- Asset Method v Income Method: Many people think that their business is worth only asset value. In fact, historically businesses were valued according to their assets only. However, in the 21st century, we are more often than not selling intangible assets, databases, trademarks, intellectual property and other intangible assets more than tangible assets. In fact plant and equipment rusts and gets old and stock is worth nothing if you have to move it quickly. However, you must be careful to value the intangible side of the business properly. Goodwill is often seen as an intangible asset and it can have value is a sign but both buyer and seller must recognise the difference between goodwill that will walk out the door when the owner leaves and goodwill that will be there for the new owner. Goodwill relies on loyal clients to stay and a strong brand is indeed worth paying for. Goodwill that is related personally to the owner and that will leave when the owner leaves is not valuable.
- Don’t Wait Until it is Too Late: Business owners usually sell when they have had enough. Often it is when the business slows down or the business grinds the owner down. This puts the owner in a position where there is no choice. To delay will simply mean the business loses further value. You need to look at the trends and the cycles to ensure that you sell your business at the right time in the economic cycle, the industry cycle, the regulatory cycle, the calendar cycle and the personal life cycle. You may not get all this right but if you at least plan your exit against one or more of these cycles you will get a happy result when you sell.
Understanding the deadly sins of business valuation is essential for every business owner who wants to accurately assess the worth of their company. By avoiding these common errors, you can obtain a realistic picture of your business’s value and make informed decisions based on reliable information. However, navigating the intricacies of business valuation can be complex, and seeking professional assistance is highly recommended.
Our team of experts specialises in business valuation and can provide you with the guidance and expertise you need. Don’t let these mistakes hinder your business’s potential. Take action today and contact us to ensure a comprehensive and accurate valuation of your business. Together, we can unlock the true value of your company and pave the way for a successful future.