Smashing the Myths of Business Valuation

You might think somebody who'd worked years to build a business would have a good idea of what that business is worth. Unfortunately, few do, suggests Marian F. Cook, a New York business transition consultant and co-author of "Selling Your Business for More: Maximizing Returns for You, Your Family, and the Business."

Entrepreneurs often enter the process of selling their creations festooned with misunderstandings about the process and, especially, what the business is worth. Cook says the following four myths particularly cause trouble for business owners en route to cashing in.

Myth: The price is the price, no matter who the buyer is.
Reality: There are two major categories of buyers: strategic and financial. Strategic buyers are operating companies. They want to continue to grow in that industry by making acquisitions of similar companies. In many cases, that involves reducing the overhead in the acquired company to make it more profitable. When that's the goal, the seller can often get the best price for the company.

The other type is usually an investor group such as a private equity firm or a venture capital firm. They're looking to invest in an industry. They want to back a management team and grow that company within the industry. There isn't as much interest in reducing overhead to increase profitability, so they are generally going to pay less.

Myth: When selling a company, a big uptick in earnings is good.
Reality: A sudden uptick in revenue doesn't necessarily equate to a sudden uptick in business value. Steady growth in revenue and earnings is much more desirable. If revenue has jumped up recently, buyers ask: How sustainable is this?

Steadier growth, increasing profit margins and an expanding percentage of revenue flowing to the bottom line are indicators of quality companies that will get a higher value. More money is good. More money consistently is better.

Myth: One great customer is all you need.
Reality: A broad base of diversified customers is better than a few large ones. Predictability has value. When you have a number of customers -- the largest of which is less than 10 percent of your revenues -- that suggests security and higher value. If a customer that's 30 percent or 40 percent of sales is lost, it could be a huge negative. Being overly dependent on a few customers represents risk.

Myth: It's good to be king.
Reality: Businesses can be cults of the owner. And an owner can build the business so it can't function without him or her. It feels good to be the center of the action. But while good for the ego, when it comes time to sell the business it presents a real barrier.

I have heard of potential buyers asking sellers if they can fix the computer network. When owners say yes, it is a bad sign. They are too involved in the details for that buyer to feel confident that the business will run without the current owner. Leadership is the art of getting things done through other people, not doing it all yourself. One thing that particularly adds value is a quality management team. You want the business to exist without you. Build it so it can.

Image courtesy of Flickr user Ian Muttoo, CC2.0