Selling a Business: The Valuation
14 February 2022: Selling a Business – The Valuation
How can you think about selling a business without knowing what that business is worth? And how would a buyer get comfortable enough to make a serious offer to buy a business without having some sense of its value?
Whether you’re a business owner or business broker – or real estate agent – working with a business owner, knowing what the business you want to sell is worth is crucial. But business valuations are required for dozens of reasons, not just for selling a business.
Divorces, life insurance, partnership dissolution, financing, legal disputes, buying out an owner, bringing in an equity partner and buy/sell agreements are among the many reasons businesses need to be valued. And while knowing the value of a business in all those situations is important, when selling a business, having the business valued is essential.
Though we teach how to value businesses in our course, “Learn How to Value and Successfully Sell Businesses“, we often get questions from course participants about the advisability of using online valuation tools or software. We don’t advise it for reasons I’ll get to in a moment.
Some Examples of Necessary Valuations
Some of our clients want – really, “need” – annual valuations. Fast growing businesses can experience rapid changes in value and certain aspects of the business may be dependent upon that value.
For example, for years we did an annual valuation for a healthcare client that was growing at a rate of roughly 50% a year. There were five owners of the business and life insurance policies were in place so that, in the event of the death of one of the partners, the company would have the ability – using the proceeds of the life insurance policy – to buy the deceased partner’s equity from the deceased partner’s estate (rather than have the deceased partner’s delinquent siblings as NEW partners). In order to insure that there was enough insurance in place, the business had to be valued every year.
Another client used its business as collateral for a funding package it planned to use for expansion. One of the lender’s stipulations was that the business be valued annually so that the lender could see of the business’ value equaled or exceeded the loan-coverage ratio that was one of the conditions of the financing.
As a rule, sellers generally have an exaggerated opinion about the value of their business. This is particularly true if the business has provided a comfortable living for the owner’s family.
In many cases, we hear about how the business provided nice cars, a second home at the beach or in the mountains, the kids education and many luxury vacations. But when we’re approached by a business owner about selling a business, we explain that, if the owner wants to have a reasonable chance for a successful sale, the price expectation must be related to value. If they don’t know what the value is – and they don’t – the price they expect may be completely unrealistic. The result of bringing the business to market without knowing its value will be a lot of wasted time and money – mostly ours.
That’s why we won’t accept an engagement to sell a business unless the seller gets a valuation done – by us or by any other qualified professional.
We offer a comprehensive coaching program tailored to Realtors, business owners and anyone interested in buying or selling a businesses.
If you’d like to learn more, email me at joe@WorldwideBusinessBlog.com
Several years ago, we did a post about statistics; specifically, about how many businesses that come to market don’t sell. Unfortunately, the quick answer to that question is “most of them“.
That post listed about a dozen reasons that businesses don’t sell. The Number One reason was because the price was too high. Business owners have got to understand the importance of setting a target price that bears some relation to value. If the business is worth $2.5 million but the owner wants $4 million, the business is extremely unlikely to sell. Without a valuation, no one on the seller’s team will know why few potential buyers materialize.
Buyers are generally smart people and can do the quick but simple math necessary to get a sense of the business’ value. If the price is significantly higher than the estimated value, no one will even waste time making an offer. The business just won’t sell.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to value and sell businesses.
Become a Professional Business Broker…
Valuations Help When Selling a Business
When selling a business, one of the more significant benefits of knowing its value is our ability to justify the price we’re asking for it.
We use the valuation report as a sales tool. If done properly and packaged professionally, we’ve found that few serious buyers will be able to argue about the price. Sure, they may try to pick a nit here or there but serious buyers are willing to pay a reasonable price for value. A professional valuation report – ours run between 20 and 35 pages – enables us to walk a buyer through the valuation process so that they can see what the business really puts into the pocket of the owner, what the buyer’s return on his or her investment will likely be and how the business will pay for itself while still offering a buyer an income to support his or her family.
Yes, we’ve had a few knuckleheads that just had to take issue with a seemingly inconsequential aspect of the business but in most such cases, these buyers weren’t serious.
Having a professional valuation report eliminates any buyer confusion as to how the seller arrived at the asking price. It provides a sense of transparency and reduces the buyer’s natural concern that the seller is trying to hide something.
Selling a business is a challenge in the best of situations. It’s incumbent upon us to make it easy for the buyer to buy!
Online Tools and Other Valuation Software
As I mentioned at the top of this epistle, we often get questions from people that take our Course – particularly from real estate agents – about how we feel about the various business valuation software programs that are often flogged to beginning business brokers. The quick answer is we don’t like them and we don’t use them.
Every deal is different. Every deal has its own specific weirdness – whether that be industry-specific, owner-specific, geography-specific, jurisdictional-specific, cultural-specific or any other “specific” uniqueness. It’s impossible for even the nerdiest propeller-head to anticipate every conceivable unique aspect of any deal, good or bad.
We’ve tried a couple of these tools and cannot recommend them. Their input cannot be totally comprehensive and, therefore, their output cannot be complete or completely accurate.
If you use one of these tools and a potential buyer discovers an error that is the result of imperfect software (which essentially is ALL software), everything in that software valuation report – and everything the seller or the broker tells the potential buyer – will be viewed with the proverbial jaundiced eye. This, in and of itself, is the strongest argument against the use of valuation software.
Though we’ve developed our own financial spreadsheet for data inputs – which eliminates most of the repetitive aspects that all valuations share, we value businesses the old fashioned way and we advise anyone in our network to do the same. Do the research. Know and understand the numbers. You are much more effective – and much more believable – when you do.
The Bottom Line
Selling a business takes work – which is one reason that successful sales pay so handsomely. And whether you’re a business owner or a broker helping a business owner, that work starts with the valuation
Brokers should expect some push-back from some owners about having a valuation done. After all, they’re accustomed to having real estate agents provide something called a “competitive market analysis” when selling their home. At no charge.
But a competitive market analysis for a house is vastly different from – and requires much less work than – a business valuation. We get paid for any valuation we do and we advise all brokers in our network – and anyone who takes our course – to charge for their time; just like the business owner’s lawyers, accountants, financial planners and all other professionals.
Don’t be shy about this. We’re at least as important to a successful sale as any of those other professionals.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
We have a buyer for small digital marketing/web design/hosting company based in the U.S. By “small” the buyer means one with discretionary earnings of less than $500,000.
If any of you know of something that might fit, please let me know.
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The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com