Mark, should I get a valuation report on my business? My typical answer is, “Absolutely.” But I always have reservations, and I convey those to the owners asking me this question. I don’t want to disparage valuation experts, but there are limitations to their process.
The Limitations of Business Valuations
I get it. Valuations are needed for estate planning purposes and during times of family breakups. They can also come in handy when one owner is wanting to acquire the ownership interests of co-owners.
If you fall under a different category – just wanting to get an idea of the value of your business – be aware of the limitations of these business appraisals:
- The valuation process is nothing more than a math excercise. It does not mimic the market effect.
- Since the valuation process is mainly a math excercise, it cannot adequately measure what business brokers are great at when selling a company – creating an auction effect and creating urgency in the process. The more buyers showing up at the party, the more the seller can expect in return. It’s impossible to incorporate this dynamic in the valuation reporting.
- The final number is typically the floor of what you can expect should you sell your business, not a ceiling.
Let me offer a counterpoint on the second item above. Valuation experts generally look at past sales of businesses to obtain a range of EBITDA multiples that could apply to your business. Still, the authors of these reports tend to err on the side of conservatism. Hence, we’re looking at a floor, not a potential ceiling.
Alternatives to Valuation Reports
Let me be clear, I’m not a valuation expert. But I certainly understand the process of buying a company. That means I approach valuation from a buyer’s point of view, and that’s how I explain this process to business owners.
There are qualitative aspects to consider too:
- Is the business growing?
- Is there customer pricing flexilbilty?
- Is the business model fluid and solid?
- Strong management team?
- Does unique IP exist?
- Is the market growing or shrinking?
There’s more to add to the list above, but that’s a starting point.
I’m not saying don’t go through a valuation process. It can be very educational. But just be aware of the limitations.