The Madness of Small Business Valuations

The following scenario is all too familiar within the small business sales market;

Decent Business + Genuine Seller + Willing Buyer(s) + Excessive Valuation = Lost (No) Deal

Selling a small business is not always easy, so to burden the process with an excessive and barely credible valuation = one likely conclusion, vendor unhappiness.

These are the primary factors that lead to problems;

Sellers Price Expectations

Most sellers have limited knowledge of the business sale process and how to arrive at a valuation. If the seller believes (or has been advised) that their business will achieve X, then they will naturally expect to achieve something close to that number, even if it bears little reality to the market.

Worse still, they may decide to price their business based on what they need to achieve, great if you’re dipping your toe in the water but as an ingredient for achieving a sale ... likely to be a recipe for disappointment.

Everyone is an Expert

Business valuation “experts” lurk around every corner. From the golf club to the networking group to the online forum and yet, most of it is detached from the realities of selling a small business.

A proliferation of online guru’s help to create a fog of different theories with some providing advice that could have a negative impact on value.

Below are two extracts of online advice about business valuations – both taken from otherwise excellent websites;

“get a figure in mind and stick to your guns”
“be clear in your own mind about the amount you wish (or need) to realize”

Well meaning but misguided advice because trying to achieve a sale price for small businesses, based on sticking to your guns or being clear about the amount you need, is almost often a route to frustration as the seller digs in for a price that is simply not matched by market appetite or reality.

The Pre-Sale Valuation

We have a mantra about pre-sale valuations – which we repeat until we’re blue in the face (literally) – and that is, for smaller businesses they’re almost pointless. The market will set the price so the key issue for an owner is to concentrate on how increase the value of their business with a combination of good preparation and extensive marketing.

Unfortunately, some advisors will use the excessive valuation as a marketing tool for securing clients – it’s no different from the estate agent beauty parade however, a business valuation contains so many variables that it’s more open to manipulation than property pricing. All the excessive valuation does is raise expectations for sellers and create barriers to buyers.

The Adjusted Net Profit

The adjusted net profit calculation is often a necessary mechanism to help extract the true earnings of a small business. There is often a legitimate debate between parties as to what should be included, so it’s important that the calculation is credible and justified.

This is not always the case as some sellers and advisors include a range of unjustified items that helps to inflate the bottom line and, by using the multiple principle of valuation, over inflate the asking price.

We encountered an example this week. Nice business and keen sellers but both of them burdened with a valuation anchored by an over the top adjusted net profit. They’ve already burned potential buyers and as the price gets reduced, the seller becomes demoralized and real value decreases.

What To Do?

People take their businesses to market for different reasons and with different expectations.

If you’re not particularly committed to selling and want to dip your toe in the water, then you might fix on a price you want/need and then gauge market reaction. Luck and timing often play a part in selling a small business but remember, the sale process is often demanding and will distract you from running the business.

However, if you’re genuinely committed to selling your business – however big or small – then forget about pre-sale valuations and asking prices. Drive up the value of your business by concentrating on what really matters;

- Making the business as profitable and sustainable as possible
- Trying to create a management structure that removes the owner operator
- Preparing thoroughly, including up to date accounts
- Creating as much buyer interest as possible, particularly from strategic buyers
- Generating multiple offers