Estimate of Value vs Reality
The following is a true story. The names have been omitted to protect the guilty but the numbers are real; real scary.
The front page headline of a recent edition of a newspaper I subscribe to read, “(Business name), Valued at Almost $6M, Sells for $750,000”.
Valued by whom?
How could something worth $6 million be bought for $750,000?!?
Well, the answer, of course, is that it can’t be. Obviously, it was not worth the $6 million that somebody arbitrarily said it was. So, what happened? Where did the six-million-dollar figure come from and why was it so far off?
Business brokers and business owners have to be aware that all sorts of numbers might be thrown around as various people – some reasonably knowledgeable, others completely clueless – try to “guess” the value of a business. It is situations like this that underscore the value – indeed, the NEED – of doing a legitimate, professional valuation.
Where’d That Number Come From?
In the case cited above, this business sale included real estate and the value of the real estate, as determined by the county assessor, was nearly $6 million. But remember, a business is almost always valued based on how much money it can put in the pocket of the buyers.
Now, let me state upfront that I don’t know the real estate involved in this particular transaction. Perhaps it is a large, deep-water parcel ideal for a liquid natural gas export facility and zoned appropriately. Or maybe it is sitting on 80 million barrels of crude and the environmental lobby is otherwise occupied in various lawsuits to keep the southern border as porous as possible thereby reducing the likelihood of lawsuits to stop any drilling permits. The assessor may (or may not) know all this.
But in this case, those possibilities are doubtful. The buyers bought the business – and publicly stated that they plan to invest $3 million in “capital improvements” in that business. Given that the cost of building an LNG export facility or the infrastructure to extract 80 million barrels of crude would significantly exceed $3 million, this statement leaves little room to believe they will be doing anything other than operating the existing business.
But perhaps the assessor valued the real estate not as it is currently being used but rather at its “highest and best” use. If it is 40 acres of prime waterfront property with wide sandy beaches in an area of high growth with growing demand for million dollar homes, it is conceivable that it could be worth $6 million. But if that was the case, whoever was advising the sellers did them a grave disservice.
The Broker’s Responsibility
A professional business broker’s responsibility is to advise its clients how best to reach the optimum outcome of the sale of the clients business assets. Usually – but not always – this means the business itself. When you’re approached by a business owner that wants to retire or move on to other pursuits and you determine that the owner’s business is worth $750,000 but is sitting on a $6 million parcel, common sense would suggest that you advise your client to close or move the business and sell the real estate so that it can be developed to its “highest and best” use.
Yes, this may mean no commission to the broker but three very positive results will redound to the broker’s benefit.
First, the broker will get paid – and handsomely relative to the amount of work he or she will have do. How? By referring the seller to the right real estate broker.
If you’re a business broker confronted by this situation and you don’t have a real estate license AND extensive experience in commercial real estate, you would, if you were smart and ethical, refer the seller to a competent, experienced commercial real estate broker. That broker will pay you a referral fee – a percentage of the commission that broker receives at the sale.
Second, whenever that commercial broker hears of or gets approached in the future by a business owner that wants to sell a business, in all likelihood, that broker will refer the owner to you.
Third, your original client – the one you referred to the commercial real estate broker – will be singing your praises to all his or her business-owning friends.
Our course, The “How-To” of Becoming a Business Broker”, devotes a lot of time to real estate and working with real estate brokers.
Become a Professional Business Broker and learn how to value and sell businesses…
Not long ago, near where I live, there was an old seafood shanty that was built in the early 1950s. Though it sat on a fabulous beachfront parcel where a small, placid river joined a wide and open bay, it was really in the middle of nowhere. There were only a few beach cottages nearby and only one two-lane road – mostly unpaved – provided access.
In the 1960s, developers started to build some larger, year-round residences nearby. The city began to add more roads – and actually paved them! Business was good. The owners put on a small addition, added heating for the winter and expanded the menu.
Over the years, as development in the area continued, customers started arriving by boat, beaching their craft on the sand and walking up to eat shrimp, crabs, clams and sundry other delicacies.
By the late 1980s and early ’90s, the joint was jumping. The children of the husband and wife that started the business 35 years earlier had taken it over and continued to expand the restaurant to accommodate the crowds. A second addition was added and they enlarged the kitchen to meet demand. In the mid-’90s they added even more space and an outdoor bandstand. What was originally a small open-air seafood shack had morphed into a local landmark serving hundreds of meals a day.
But as is so often the case, the next generation was not interested in the long hours and hectic pace that, given the restaurant’s growing prominence and notoriety, running the business required. They decided to sell.
The business was generating the proverbial boatload of money. The owners were livin’ large. The joint had such caché that other restauranteurs and restauranteur wanna-bes were lining up for a chance to own this high-producing local landmark.
But in an instance of illustrating the value of having the right team, the owners were advised that their business was sitting on what was now one of the most valuable pieces of real estate in a 50-mile radius. Though the restaurant was generating enough cash to warrant a value of nearly $3 million, the real estate itself was worth $8.5M. The property now sports 158 condo units, most with fabulous views.
The Bottom Line
Know what you’re selling. Whether you’re a business broker or business owner, make sure you know the true value of what you’re dealing with. Don’t listen to the accountant’s guess, the attorney’s estimate, the assessor’s assessment or your cousin Mortimer tell you that, if Facebook, with revenue of roughly $50 billion, is selling for 18 times earnings, your $6 million specialty metal manufacturer warrants the same multiple. It doesn’t.
Hire an experienced professional business broker to do a valuation. Know what you’ve got and act accordingly. Don’t end up on the front page of some Local Font of Knowledge as the subject of an article that makes everybody involved – with the possible exception of the buyer – look foolish.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want 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 profitable week!
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