It’s no fun to tell a songwriter his song is bad. Telling a novelist her novel won’t sell takes nerves of steel. Telling a new Mom her newborn is not the cutest child in the nursery, well that’s just downright dangerous! Telling a business owner what his business is really worth is no way to make a friend, much less gain a client.
Over two decades of buying and selling businesses, I have observed that most business owners have unrealistic valuation expectations. Exacerbating this disconnect, few business brokers will be completely honest with the business owner who has an unrealistic valuation. The broker will tell the owner what the owner wants to hear about his valuation so as to get the assignment hoping just hoping the owner will lower his expectation once offers come rolling in.
Problem, over-priced businesses usually don’t generate many offers, and when they do, the business owner feels insulted, and all the blame goes to the where it belongs, the broker who wasn’t honest in the first place.
So why do most business owners have an unrealistic valuation expectation? First, they value the company based not on the business’ metrics, but instead on what they want from the business. It usually goes something like “here’s what I need for my retirement…..” or “I need this to get my debts paid off.” Second, too often business owners have the mistaken impression that the metrics driving publicly traded valuations apply to all businesses. Suffice it to say, a multiple on GAAP earnings of a publicly traded company is apples-and-oranges to a multiple on cash flow of a privately-held company. Perhaps the most prevalent reason for an unrealistic valuation is when a business owner thinks its value is driven by what the business can be, instead of what it is.
But instead of being honest with the business owner about why his/her valuation is too high, most business brokers will just take the assignment and hope for a lightning strike. So before you head down the road of trying to sell your business, here are some basic tips you should consider.
While every situation is different, there are some general rules that apply to valuation of small privately held businesses. Here’s how it works: first, look at cash flow (not earnings) for the most-recent full year, and the two years before that. Next, look at your average growth rate over that three-year span and apply that growth rate to your most-recent full year cash flow and that will give you your cash flow projection for next year. Then, take the average cash flow for those four years and multiply by three. Next, add to that number the cost value of your inventory, and 80% of your Accounts Receivable, and that sum will give you a good perspective on your current market value. Finally, asks a competent, honest and experienced business broker, like those affiliated with The Tennessee Valley Group, to test your assumptions (there might be accentuating circumstances that justify different analytics).
So how is your small business valued? — simple arithmetic applied to your core business metric, cash flow. There, the secret is out.
Tennessee Valley Group
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