Business owners often have a skewed perspective of how much their business is worth. Understanding what variables have the greatest impact on business value and deal terms are important for any owner, whether or not you are selling now or planning to do so down the road. Here are the top 2 reasons owner expectations don’t align with market realities:
- Thin air. Many owners attach themselves to a number at which they want to sell their business without any financial foundation or understanding of the valuation process. The owner may reminisce about the years of hard work poured into the company, then envision a retirement lifestyle that rewards this labor. A number appears, my company should be worth $5 million. A financial advisor or accountant may then reinforce this notion because they don’t have an understanding of the market. As human beings, it is easy to form emotional attachments to such numbers because of what they symbolize for us – our success, comfort, or even survival. The reality is, in general, companies only sell for multiples of 1 to 3 times SDE¹ or 3 to 6 times adjusted EBITDA². Although many years within an industry are beneficial, there are many factors assessed in valuing a business and it doesn’t earn an owner special multiples. To ensure your expectations align with the market, calculate the range of valuation multiples for SDE and EBITDA for your business, or contact us for a basic free business valuation.
- Blind to business risk. Buying a business is inherently risky. An owner may perceive his company to be as safe as buying Treasury bills, while a buyer views the investment risk at the level of a junk bond. The discount rate for the cost of capital associated with buying a business is high, about 25% – 35% on cash flows. Owners often have difficulty identifying business risks and potential problems for the next owner. For example, if the company is heavily dependent on the current owner, an exit may be extremely difficult and affect future company profitability. This is especially true if key relationships are based upon the owner. Not only does this diminish the valuation, but it will also affect deal terms such that the owner may have to accept that some of the transaction consideration will be paid over time. Take a step back from your business and put yourself in the buyer’s shoes. Our Value Adviser Reference Guide identifies 6 key areas of risk that buyers are concerned with.
1 SDE: Seller’s Discretionary Earnings is EBITDA plus all owner compensation and benefits.
2 Adjusted EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization where the EBITDA is adjusted for unusual expenses and compensation, then normalized to align with market based benefits and compensation required to operate the business.