Our firm meets regularly with business owners who have had their businesses valued by a 3rd party. While these valuations can provide some good insights, invariably, the valuations often don’t adequately address the intangibles in the business that go beyond the financial statements. Of course, there are exceptions, but too often 3rd party valuations fail to address some key areas that significantly affect the market value of a business.
Below are a couple key questions a business owner should consider when obtaining a business valuation.
How are trends in the last 2-3 years applied?
Prior to the pandemic, trends over the last 5 years were common for valuations. However, many buyers are primarily focusing on just the last 2-3 years in terms of revenue and profitability. Now with many economists touting a recession, many are even carefully watching trends over the trailing 30-90 days prior to closing. Just this month, we valued a specialty construction company who had recently paid for an elaborate 3rd party valuation. While the valuation included some relevant textbook information, it did not account for pandemic related adjustments and simply ignored current industry trends tied to local new construction. Without these adjustments, the annual trend appeared to be steady but when the adjustments were applied the trend revealed a steady decline which significantly lowered the average EBITDA over the last 2-3 years. Consequently, our market valuation was over $3M lower than the 3rd party valuation. This was an unfortunate reality for the owners causing them to re-evaluate if they should consider selling at this point or wait for the trends in the business to recover.
What are the valuation methods and source for comparable businesses?
Both the method and source used for comparing a business to other “like” businesses is important to understand. Unlike selling a house, finding a “like” business is not easy but by leveraging different data sources, metrics from previously sold businesses can be applied. It’s important that the right size and industry type are considered. It seems rational that a business with $10M gross revenue should not be compared directly with a business with $100M. Yet we regularly see multiples applied to the wrong size and type of business.
For example, an owner of an IT services contracting business was valuing their business based a multiple another owner received whose business was 5 times larger in revenue. While another IT managed services business had a valuation completed comparing them to businesses more than 10 times larger in EBITDA. Both companies were in the “IT services” industry but the methods for determining the correct multiples were flawed which led to setting unrealistic expectations for the owners. Determining the ranges for these multiples for a specific business is not an exact science (despite what ChatGPT proponents may claim) which is why the proper valuation methods and sources of comparable data are critical to having a realistic valuation.
Business valuations can be useful for planning purposes but it’s important to know if the valuation is on par with the current market to ensure the right expectations are established. Our firm offers a free, no obligation, valuation assessment of a business to help business owners better understand a reasonable price range of their business. The majority of our business comes from referrals, and we appreciate your continued trust in our firm.
Robert W. Amerine
President, CBI, M&AMI