AP's Blog

One of the most frequent reasons business owners see no value in getting their business valued is because they have heard of industry multiples.  We often hear things like "In our industry, we sell for 24 months of revenues, i.e. 2x annual revenues".  Unfortunately, selling a business on revenue, or net profit, or EBITDA multiples is like selling a Lexus based purely on mileage, with no regard to of hail damage, engine condition, tire quality etc… 

Put yourself in the shoes of a prospective buyer.  Lets say you find a business with $5M in annual revenues, $1M in EBITDA and $500K in Net Income.   Would you pay a 4x EBITDA for it?  You may agree.  Now, what if I told you that sales were declining year over year, the operations were running at full capacity with no room for expansion without massive capital investment, the owner was the only management in place, A/R days were twice industry standards, staff morale was low with high turnover, and 90% of sales came from just 3 customers.  Still feel like paying a 4x EBITDA multiple?  Did I forget to tell you about pending litigation?  My bad…  Unless you are a turnaround specialist, you probably won’t feel like paying even a 1 or 2x EBITDA multiple. 

Lets say, you are now the owner of a business in the same industry with the exact same revenues, EBITDA and Net Income.  Except, you have steadily increasing sales, operations at 40% of capacity with plenty of room for additional product or service delivery capability, a diverse customer base, loyal and energetic staff, and professional management in place.  Would you want to sell for the same multiples as the above business?  If no, then you realize the need to value your specific business.

Most small business owners do not see any value in paying for a formal appraisal of their business.  Business owners have a price in mind when they get ready to sell, & usually this price is not based on a rigorous analysis of the earning power of the business.  In my opinion this is a big mistake.  There are only 3 potential outcomes when you do a valuation… and all of them are positive.

• The price you had in mind is lower than the valuation -

  In this situation, the value is clear.  The valuation prevents you from leaving money on the table.  Lets say you were willing to sell for $2.5M, and the valuation comes in at $3M.  Well, that $5000 valuation you conducted just gave you an extra $500,000.  A 99 times return on your money. 

• The price you had in mind is very close to the valuation -

  In this case the valuation gives you confidence in your selling price.  At first glance this is not a big value, but seller remorse often kicks in after a sale.  I have yet to meet a seller who wonders whether they could have negotiated a better selling price.  Its natural human tendency.  Even if you do a valuation, you will still kick yourself and wonder if you could have gotten another $20,000…   but just not that hard. 

• The price you have in mind is much higher than the valuation -

  Often times sellers do not realize how valuable this outcome is.  First it prevents you from listing your business at an unreasonable price.  You will not attract knowledgeable buyers at this price.  Even if a buyer were to make an offer, s/he could never find financing at this price.  Either outcome (not having buyers, or having buyer after buyer fail to raise financing) is frustrating and painful for the seller.  Knowing beforehand that your expectations are unreasonable gives you the opportunity to change your expectations or to work on your business before you choose to list it.