Business valuations: When speculation becomes fact
By John F. Dini, CMBA, CExP
As an exit planner, I hear lots of owners opine about the value of their company. Some are well informed, but more often than not, they don’t have the full picture.
When asked about their reasons for the value they think their business has, it sometimes goes like this: “Well, I was talking to a guy at a trade show who told me another company in his state that I think was a lot like mine sold for about $4,000,000. I’m a bit bigger than they were, so we are easily worth $5,000,000.”
You may laugh, but this particular owner used this value for a loan application he was applying for (even though it had nothing to do with the credit decision). The business owner then added it to his personal balance sheet, which was accepted without question by a retirement planner, which firmly validated the value of the business in the owner’s mind.
It’s difficult to start an advisory relationship with a client when your first discussion is about how their company may be worth a lot less than they think. It’s even worse when the basis of his fantasy number comes not from trade show gossip, but from another trusted advisor.
“My CPA (or attorney, or financial planner) told me that most businesses my size sell for about five times earnings.”
When a client requests your expert opinion, it’s almost a reflex to respond with an answer. Many professionals don’t realize that a business owner is not instinctively factoring in the dozen or more variables that may add to, or subtract from, their valuation.
However, when I ask an accountant (and I’ve had this conversation numerous times) how he or she came up with that multiple, the answer is usually more cogent and comprehensive. “Of course, I meant pre-tax earnings plus one-time items, adjusted for non-cash expenses, weighted for risk, less debt and the costs of replacement management.”
What you meant isn’t what the owner heard. He heard “five times earnings.” Moreover, he likely knows there are addbacks in calculating business value, so he is tossing in his “business” vacations and automobile, along with the family’s mobile phone plan and health insurance before he multiplies by five.
It is almost certain that he is not benchmarking his company against industry norms. What he thinks is admirable earning power, because it supports a comfortable lifestyle, may be far below the average profitability of his competitors.
A business is usually the largest single asset on its owner’s personal balance sheet. Few things are more exciting than learning that asset is going to fund a luxurious retirement and pay off your kids’ college loans. The disappointment of a reality check may be deep and bitter.
People turn to their trusted advisors for answers. We owe it to them to delineate between speculation and fact. We shouldn’t be tossing around “ballpark” numbers on something that’s so vitally important to a client unless they are based on formidable research.
About the Author: John F. Dini is an author, coach and consultant specializing in business transition strategies for Baby Boomers. He lives in San Antonio, Texas. Read his blog at www.awakeat2oclock.com.
Additional Resources
Whitepaper: How to Scale a Valuation Practice Within Your Accounting Firm
Infographic: Advantages of Software as a Service
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