It’s been our experience that business owners focus on the “urgent”, to borrow a term from Stephen Coney (The 7 Habits of Highly Effective People). They have to meet customer demands and payroll among a myriad of other daily tugs on their focus. If you ask an owner what their business is worth, it will be hard to determine a good number. There’s a “wished for” number and then there’s a number a prospective buyer may be willing to pay.
A business valuation is very helpful for a closely held (private) company. If the owner has legal objectives or an ESOP (Employee Stock Ownership Plan), there are specific rules and audits of data that must be followed. The formal process increases the validity of the numbers. An Informal Business Valuation could be compared to a horseshoe leaning on the post; not a ringer but almost there. The values used are based upon the financial person in charge of that responsibility within the firm.
There is a quote from the Latin writer, Pubilius Syrus, that states, “From the errors of others, a wise person corrects their own.” One of the objectives of the informal business valuation is to reduce errors on estimates of value so that you, the business owner, are wiser about how an outside party may look at your business. My experience has generally been an owner has an inflated value in mind for the business. Going through the informal business valuation can help them bring their value more in line with reality.
Here are some of the potential pitfalls:
If the data has been inflated, i.e. charging off personal expenses as a business deduction; yes, the owner reduces taxes due that year. However, the value of the business is impacted by whatever multiple the company might command. (Numbers written off) x (the multiple) can be the potential impact on value. The informal business valuation will not catch that reality unless the owner “fesses up.” This also can apply to family members on the payroll who really contribute nothing to the success of your company. If that person is your spouse, you are also losing the cost of Social Security and any other mandated cost times the multiple factor.
In the public market, analysts give predictions of earnings. When public companies miss these estimates, their price normally drops. The application of this reality also occurs when a potential buyer has put in a letter of intent. They want to audit your company to find the warts or “red flags” that can be used to reduce the proposed price. Building from my quote about “errors”, we have built a 22-question review that looks to uncover potential problems or issues. The goal is to change “red flags” into positive “green flags.” That is done by doing the in-depth interview applying our 22 questions. They were developed by my business partner and successor, George Abboud, and myself collaboratively. George came out of the buy side on transactions. My experience has mostly been on the sell side. We shared what we determined was important information that a potential buyer might want to know. Better to be prepared than surprised, was our goal.
Have you gone to an event that ran smoothly? Everything seemed to click smoothly. That does not happen by chance! There is usually a gifted planner in the background who has thought through each step of the process. They think tactically, sequentially, and work hard to anticipate obstacles. Creating solutions before problems occur makes an event run flawlessly for the participants. Doing an informal business valuation will help make you a wiser owner and potentially better-informed seller in the future.
Securities and investment advisory services offered through World Equity Group, Inc. Member FINRA, SIPC, a Registered Investment Adviser. SMART Group Houston is not owned or controlled by World Equity Group, Inc.
Neither SMART Group Houston nor World Equity Group, Inc. provide tax or legal advice.