Once More: The Importance of the Valuation!
NOTE: This post was originally geared toward business brokers and those that wanted to become business brokers. However, because it discusses how to value a business, much of the information, particularly the downloadable data at the bottom, is also pertinent to business owners as they think about selling or that just want to get some ideas as to the value of their business.
Businesses must be valued before they can be sold. If you bring a business to market without having determined its value – but by simply accepting the price that the seller wants for the business – there’s no telling how distant the asking price is from the business’ actual value.
Many beginning business brokers, in their quest to get listings, will agree to list the business for whatever the owner wants. BIG mistake! The owners of profitable businesses are most likely experts in their industry – and equally as likely to have no clue how to value anything other than the product or service that they sell. In fact, they are uniquely unqualified to value their own businesses, no matter how much someone told the owner a similar business in the next city was sold for.
Second Hand Information
First of all, who knows if the information about the other business is true? Sellers who gab about what they sold their business for tend to inflate the real number to impress whomever it is they are speaking to. Second, even if the number is correct, what were the terms of the deal? Favorable financing terms, inventory levels, geographic locations and many other characteristics all impact price. Third, the seller of the other business may have established a price without getting a valuation and that price was lower than value. The owner may have hired an inexperienced (or unethical) business broker. The buyer may have been financially unsophisticated resulting in a price that was significantly higher than value. There are dozens of reasons that such “second hand” information should be discounted completely.
In order to perform a valuation that will result in a meaningful estimate of value, the broker must take certain steps and review certain documentation. Such documentation includes tax returns, financial statements showing the in-flow and out-flow of revenue, the business’ balance sheet (a snap shot of the business’ financial condition on a certain date), certain contracts, etc. Without this data, it will be nearly impossible to determine a business’ value.
What if the Seller Doesn’t have – or won’t provide – that Information?
We will not accept a listing assignment without having this documentation in our files and without having done a valuation. First of all, any business buyer with a three-digit IQ will want to see the numbers. Secondly, a business broker that is unable to produce this information for the buyer to scrutinize is likely wasting his or her time if for no other reason than that without that documentation, the business is unlikely to ever sell – and the broker will be seen as a fool. Life’s too short. We walk away.
(I endured an episode similar to this and that is the reason I became a business broker. For the gory details, check out this post.)
So, the bottom line is that, before you take a listing to sell a business, you must know what it’s worth. To find that worth, you have to develop an estimate of the business’ value. To do THAT, you must have certain documentation. You can get that documentation from the owners or, ideally, from the owners’ accounting firm.
Value A Business
The valuation is arguably the most important aspect of selling a business. Do not skimp on this component. If you get any push back from the owners, walk away. You’re better off not taking that assignment than to look foolish to buyers and possibly never sell the business because the price cannot be supported by proper numbers. (Here’s where to learn more about “funky financials“.)
We’ve put together a short check list of documents and other data that you will need to perform a proper valuation of a business and it’s yours for free. Just tell us where to send it!
In addition, once you have the data needed to value the business, you’ll want to know about “discretionary earnings” – what they are and how to calculate them. Discretionary earnings are the foundation for establishing value. Get that information here.
If you have any questions, leave them in the Comments box, below. If we get enough on the same topic, I may do a post or podcast tackling it specifically.
Finally, we’ve had quite a few people ask if we have a course to teach them how to become business brokers. I’ve put together an outline of such a course that, if enough people are interested, I’ll develop and make available online. If that’s of any interest to you, let me know here.
I’ll be back with you next Monday with another post on buying or selling a business or the business of business brokering. In the meantime, be well and have a profitable week!