Would You Accept a Self Valuation of a Business?
“My business is a lot different than others in my industry.”
How many times have you heard this comment from a seller? Although this might be a common statement from a business seller, is it accurate?
When the owner of a small, privately held business firmly believes that their business is unique, the owner’s ideas about valuation of the business will often be highly flawed.
Whenever a valuation is done there are opposing parties involved. Even when a valuation is done for internal purposes, there will be the “too high” and “too low”camps when the valuation number is announced. Keeping this concept in mind will help the recipient of the valuation a more balanced perspective.
In reality, small businesses, even within the same industry, are unique due to the unique personalities of their owners. In small businesses, defined here as one with under $5 million of annual revenue, the owner’s personality permeates every aspect of the business operation – whether for good or bad.
We do not accept owner valuations with cars or houses when we buy and sell – why would it be any different in buying or selling a business? You need a independent, professional business valuation if you’re buying or selling a firm.
What Determines Business Value?
Like a car or a house, a business has many parts that come to bear on the ultimate value. Cars and houses are much more actively compared and researched, in part thanks to the internet. The public at large is fairly competent at shopping the correct value of a car or house within a tight range. The narrowing of that price down to an exact price or value is where negotiation plays a part. But what about the pricing of a business?
For publicly traded businesses, about 17,000, there is and has been an active daily trading market for the stock (equity) and bonds (debt) of these companies. Although the trading of the stock is on a minority basis (non-controlling interest), it does establish value ranges for a company. A full buy-out of the controlling interest requires negotiation on a majority basis (or company controlling interest) which generally results in a premium value above the previous stock market value (on minority basis trading).
But what about the 20+ million privately held or controlled businesses?
This is where a valuation comes into play. Many businesses are bought or sold without an independent review of value. This approach may save money in the short term, but can be damaging and costly to the buyer or seller in the intermediate or long term.
Why Are Valuations Avoided?
If an independent valuation of a business should be a part of the sales process, why is not always done? Typically, uncertainty and cost come into play.
- First, it is never certain that a deal will go through. If a deal does not close, the whole process of a finding a selling candidate begins again. Clearly this is a time-consuming and costly process.
- Second, the valuation of a business is not inexpensive process, ranging generally from a low of $7,500 to over $50,000 for larger valuation engagements. This cost, coupled with the uncertainty of a successfully completed transaction, is indeed quite a financial hurdle.
When Do You Need a Valuation?
- You are doing strategic planning and want an independent valuation of the business in order to measure progress or a starting point – you need a valuation.
- You are buying a business and need bank financing – you probably need a valuation.
- You are involved in a large multi-partner buy-sell agreement – you definitely should consider a valuation.
- Your buy-sell agreement calls for a valuation to be done after a trigger event – you know it – you need a valuation.
- You are bringing in new partner to a firm who will buy in – someone needs a valuation.
- You are doing a merger or acquisition – you might need a valuation.
- You require the determination of intellectual value of a firm’s specific assets – you absolutely need a valuation.
- You are working on minimizing estate and gift taxes – you better believe it – you have to have a valuation.
- You are concerned about your family limited partnerships and the discounts applied – you need a valuation.
- You are changing from a C corporation to a Sub-S corporation – you probably require a valuation.
- You are thinking that times need a changing and you are getting a divorce – someone will want a valuation.
- You are doing an ESOP – you will need a valuation every year of its existence.
- You are tied up in a breach of contract, insurance claim, condemnation, or some other type of litigation – you will probably need a valuation.
Just because you run a business does not qualify you as a financial expert, and certainly not as a business valuation expert. I know how to drive a car, but that does not make me an auto mechanic. Protect yourself and your investment; always get an independent business valuation!