The top five myths of valuing a private business as presented by Dr. Stanley J. Feldman, Chairman, Axiom Valuation Solutions and Associate Professor of Finance, Bentley College:
Valuing a private business should only be done when the business is ready to be sold or a lender requires a valuation as part of its due diligence process.
If a business valuation has not been performed by the time the owner is ready to sell, then you can be sure critical business and estate planning issues have not been appropriately addressed. As a result the owner is more likely to have adverse tax effects upon sale and/or have a more difficult time finding a potential buyer.
- Businesses in my industry always sell for two times annual revenues. So why should I pay someone to value my business?
Value multiples, such as “two times annual revenues” are rules of thumb and should not be used as the sole indicator of value for a business. The multiples are generic and will not provide the business owner with the kind of analysis necessary to obtain the appropriate value for planning purposes or when it comes time to sell. When using only rule of thumb values the business owner will often leave money on the table or set a price so high the business fails to sell.
- A local competitor sold his business for three times revenues six months ago. My business is worth at least this much!
What happened six months ago may not be relevant to the value of your business today. A multitude of factors could have changed in that time including but not limited to: interest rate modifications, changes in the industry and changes in the local or national economy. In addition, the company that sold six months ago may be in the same line of business but may have different cash flows or were possibly purchased by a strategic buyer who was willing to pay more for their specific business. The fact is, every business is different and although recent sales may be an indicator of what you might get for your business, these are only starting points upon which a more thorough analysis should be performed.
- How much a business is worth depends on what the valuation is used for!
The Internal Revenue Service has a definition of fair market value that business appraisers adhere to. The definition is as follows:
The value, expressed in cash or its equivalent, at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
When determining the fair market value of a business, appraisers will adhere to this definition no matter the reason for the valuation.
- Your business loses money, so it is not worth much.
What your business shows as net profit on its tax return and what is actual “net benefit” to the owner of the business may be two very different numbers. One must consider the benefits the owner gets to take from the business such as:
- Year-end bonuses or high compensation
- Vehicles and/or mileage costs paid by the business
- Medical costs paid through the business
This is only a short list. One could most certainly think of three or four more perks that may be paid through your business that may help enhance value.
In conclusion, we believe it is important for our clients to have all of the available facts when it comes to the value of their business. Whether that means they need a complete appraisal or just a calculation of value to use as an analysis for planning purposes the advisors at Terry, Lockridge & Dunn are available to assist you through the business valuation maze.
Feel free to give us a call at 319-364-2945 to set up an appointment to discuss what your business might be worth.
Terry, Lockridge & Dunn, Inc. provides real advice to give the business owner an edge when it comes to succession or exit planning. Steven Covey who wrote “The Seven Habits of Highly Effective People” said it best when he said “Begin with the end in mind”. It is never too early to plan your business exit strategy. Terry, Lockridge & Dunn, Inc. will send electronic mail similar to this periodically – If you are not interested in receiving future messages, please reply to this email.