My Company is Only Worth That Much?
Michael Ella, CPA, CEPA, Director of Family Wealth Consulting, KeyBank
Business Owner: My company is only worth that much? That’s not what I have been told before. Why?
Value Advisor (CEPA): When you hear values thrown around from people who don’t know a lot about your business, they typically generalize, and they give rule of thumb, which can be misleading.
Business Owner: But I need more to be able to retire!
Statistically, 80 percent of businesses put on the market do not sell, which is alarming considering we are in a seller’s market. Among the most common reasons are:
- Unrealistic value expectations
- Owner dependency
- Belief the business is ready to transition
- Customer concentration issues
Let’s consider the risk of unrealistic value expectations for a moment. When we talk with business owners, only on rare occasions does an owner underestimate the value of the business when compared to the valuation determined by any mergers and acquisition advisors. This is primarily because owners far too often are unable to be objective with regards to their own company, where they have worked very hard to build and grow for 10, 20, or even 30 years or more. For this very reason, it is imperative for owners to seek the perspective of an objective third party (an educated value advisor), who can and will look at the business through the eyes of a hypothetical buyer.
Unrealistic value expectation issues often stem from an owner hearing about a “multiple” that they feel should be applicable to their business. Though there are many different valuation methods, a very common method involves the use of a “multiple” that is applied to some of the company’s key financials to determine the value of the company. Most commonly, a company’s normalized EBITDA (earnings before interest, taxes, depreciation and amortization) will be increased by a certain “multiple” to determine a valuation for the company.
Loosely applying a multiple they have heard about can be one of the worst things a business owner can do, providing them with a false sense of what the business is worth, making it difficult for them to be open to other thoughts about what the company is REALLY worth (as determined by a valuation expert), and leading to an unwillingness to sell at market values.
Note, valuation multiples are typically really an average range for a specific industry or type of business, with both a low and high end of the range. Determining that range of value takes much more analysis than simply knowing your company’s normalized EBITDA. It is necessary to understand the strength of your management team, strength of your value proposition, growth plan, historical growth, customer relationships, owner dependency, barriers to entry, strength of brand, among other factors, to more accurately determine where within the range your company may fall.
It's important to understand that most companies trade within this range of values. Understanding where your company may fall within the range can be invaluable, providing a benchmark from where the business owner can continue to build and grow their value, identifying the potential value gap between the current value of the company and what the value could be if the owner incorporated a value optimization process, and providing a data point to be included within an owner’s personal financial plan to ensure there are enough assets to meet their post-transaction financial goals and objectives.
When you hear of “multiples,” be aware of their relevance to you, your company, and your specific situation. If you do not know how to get started, or what your first step should be, education is the answer. Educate yourself on how businesses are valued, and more importantly, how a hypothetical buyer would use information to reduce the value of your company.
Although owners do not necessarily need an expensive valuation to have a realistic idea of where they stand, if you are serious about determining the true value of your company in any potential sale, consult with an expert in valuations before drawing your own conclusions.