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The #1 Best Kept Secret To A High Valuation

When the time comes to sell a business, most business owners start with getting a valuation done. One needs to know the asking price before putting a business up for sale, right?
Wrong! (Or so argues Clinton from UK Business Brokers )

Any valuation done by the owner of the business is pretty worthless, in my view. Buyers
and investors don’t trust that valuation (no, not even if it was done by an “independent”
valuer). Why should they? Vendors have every incentive to inflate the valuation or, at least,
manipulate the figures provided to the independent valuer.

Buyers will come to their own conclusion on value. They’ll collect accounts and data from
the business, crunch the numbers, perhaps consult with their professional advisers …and
calculate their own figure. This almost invariably a much, much lower number as their own
subjectivity comes into play.

The smaller the business the greater the subjectivity involved with valuation. Heck,
subjectivity skews the value of even listed companies (their price, or value, changes from
minute to minute as shareholders buy or sell shares). Both parties could argue as much as
they want about whose valuation is more “accurate” but the truth is that there is no one
accurate valuation for a business.

Both valuations may be perfectly correct depending on what assumptions and other
subjective data were fed into the formula. The bottom line is that there’s usually a valuation
gap between buyer and seller. And if both parties can’t throw away their respective
valuations and agree some terms, no deal gets done.

I propose an alternate approach.

Here’s what normally happens: The business owner wanting to sell his business approaches a party to value his business for him. It may be his accountant, a professional valuer or a business broker. The person doing the valuation asks for some data, typically accounts.

The valuer then goes away and applies one of numerous formulae to that data. He may
take profit and multiply it by an “industry multiple” (multiples currently being seen by other
businesses sold in the same industry). Or he may create projections of future income
based on the current growth trajectory and compute a DCF or discounted cash flow (which
is effectively today’s value of the company’s future cash flows).

The flaw in the valuation

Whatever the method used, there are many flaws. The first is that if basing the calculation
on projections, there’s enormous subjectivity involved and there are assumptions that the
business will continue growing (and growing at the rates seen in its recent history).

If basing the calculation on profit… there is no one “profit” figure! Are we talking just last
year’s profit or the average profit for the last three years? Or is it the average profit for the last five years? Is that pre-tax profit or post tax profit? Or is it EBITDA (Earnings Before
Interest, Tax, Depreciation and Amortisation)? Or is it an average EBITDA over …well, you
get the picture.

There’s a flaw with the multiple used as well. If businesses in this sector are selling for an
average of 5.3x earnings, that doesn’t say much. We need to know the spread. If
businesses in this sector are selling for between 5.2x earnings and 5.4x earnings then
using 5.3 is a fairly good approximation. But what if the range really is 1x – 100x (with a
large number of businesses achieving just 2x or 3x)?

Averages fail in this situation as other business attributes, attributes other than profit, are
affecting the multiple based calculation. Any valuation provided as a wide range – of
between 1x earnings and 100x earnings, for example – is as useful as a chocolate teapot.
So what’s the business owner to do?

I advocate a different approach and one with which most owners of small businesses
really, really struggle.

And that is to stop trying to reach a decision on how much your business is worth! That’s
pointless as it could be one of any number of numbers. Your valuation is irrelevant.
There is a more important problem to address and that is on how best to influence the
factors that the buyer is going to be using in calculating his valuation figure.

The importance of this cannot be overstated. No matter how much you think your business
is worth you aren’t going to get that figure unless a buyer see that value in your business.
And buyers don’t see value easily, you have to create the conditions for the buyer to see a
higher value.

So how do I convince a buyer to see value / to pay more?

The worst way to try and convince a buyer to pay more is to talk the business up, to wax
lyrical about all its great features, the tremendous potential it has, the huge opportunities
that lie ahead.

Buyers are not fools. Before buying a business they put a lot of effort into investigating
every little bit of it; that’s called due diligence (DD). DD tends to cost thousands in legal
and accountancy fees. When they’ve done all that investigation they’ll come to their own
conclusions on the potential, the opportunities, the everything. And they’ll arrive at a
valuation based on what they’ve found, not on what you’ve told them.

The more you try to pitch, pitch, pitch, the more you are putting the buyer off.
So, instead, how about a different approach? Focus on what floats the buyer’s boat. What
buyers want, and what buyers see value in, is very different to what sellers think that
buyers want.

Spending the time to find out what influences the buyer’s valuation the most, and working
on creating those attributes, or making changes to the business so the buyer finds the
good bits he’s looking for, is a far best use of time and resources than starting off with an
arbitrary valuation.

Such effort directly affects the most important number, the number that the buyer is going
to calculate. Influencing his perception of value is a highly skilled job. To best do this,
business owners would be wise to get the right representation, the right broker or other
adviser, someone who can target and influence the buyer’s perception on value.

All the best with the sale of your business.

Visit UK Business Brokers website here

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