Valuation Traps

If you own a business, at some point you’ll probably need to know what your business is worth. It might be for estate planning purposes, a major life event, or perhaps you’re thinking about selling your business. Whatever the reason, there are some “valuation traps” out there, so we wanted to address those for you today so you can avoid making a costly mistake.

Common Valuation Traps:

1. Assuming that just because your CPA does your financials and tax returns that they can value your business. While there certainly are CPAs who are proficient with business valuations, they are few and far between. Although their intentions are usually good, CPAs generally do not have their finger on the pulse of the market, don’t have access to comparable databases, and tend to use the same methodology (like a discounted cash flow model) on all businesses regardless of size, scope, scale, or industry. While your CPA may seem like a logical place to turn, it’s best to let them do what they do best and find a professional service provider who values businesses for a living.
2. Reading articles online about businesses that have sold that might be similar to yours. If a business transaction makes the front page of the Wall Street Journal, it’s probably an outlier. And although it’s fun to dream about making a gazillion dollars, just because Google paid a ridiculous multiple of earnings for a company doesn’t mean that a “normal” buyer will pay that for your business.
3. Reaching out to a buddy who sold his business to find out what it sold for. It would be great if it were that easy, but your business is unique and factors that influence a valuation vary greatly. Even if your buddy is in the same industry as you are, do they have the same infrastructure? The same margins or growth rates? How about recurring revenue or client concentration? So many factors affect the value of a business, so resist the urge to apply a “rule of thumb” based on what someone else received for their business.

Now that we’ve identified the common traps (which produce some pretty outlandish expectations, we might add!), let’s talk about how to value a company the right way. First of all, you need to identify the PURPOSE of the valuation. If you want to know what your business would likely sell for on the open market, you need to get a Broker Opinion of Value (BOV) from business broker who has a strong incentive to get it right: Too low a value means that everyone leaves money on the table; too high a value and the business broker will be working for free because it won’t sell. Keep in mind that some business brokers will “buy a listing” by tickling your ears and telling you what you want to hear up front so that you’ll list your business for sale with them (some even charge a monthly retainer), only to find out later that it wasn’t realistic. Don’t fall for it or you could waste a lot of time and money before you finally settle into the right price range.

If your valuation purpose is something else such as litigation, securing a loan, converting from a C-Corp to an S-Corp, etc., then you’ll need a certified valuation professional with the credentials required to defend their value in court or with the IRS. These reports can get pricey, but all these experts do is value companies and defend them, so you want some serious horsepower. Fortunately, we have great relationships with trusted professionals in this arena and we’re happy to introduce you.

In summary, beware of the traps we discussed above so you don’t end up with false expectations or unnecessary delays. Contact us if you want to know what your business is worth on the open market; we promise to shoot you straight. If you have another reason for valuing your business, let us know and we’ll connect you with the right expert for your situation. We are honored to be a trusted resource and will point you in the right direction.