By Mary Ellen Biery
If you’ve ever watched the ABC series “Shark Tank,” you’ve seen the following scenario happen again and again: Business owners think their companies are worth way more than the investors do.
As “Shark” Daymond John once noted, even in the fifth season of the show, “People still come on there and say, ‘My company’s worth $20 million because I will do that in 10 years,’ but the value of the company today is not worth that.”
Many business owners place unreasonable valuations on their companies, which is fine until they actually want to sell their companies. Indeed, according to a recent survey by Pepperdine University’s Private Capital Markets Project, investment bankers and business brokers said about 1 in 3 of their engagements to sell companies last year fell through without a deal closing. And a valuation gap in pricing was often the top reason reported.
The same survey, meanwhile, showed that about two-thirds of nearly 1,000 business owners expect to transfer ownership within the next 10 years. This raises the question of whether those owners will be compensated fairly or will be left disappointed and wondering where they went wrong.
The fact is, the large majority of companies in the U.S. are privately held, but valuing private companies is tricky, given the nature of privately-held businesses. Estimating a company’s future financial performance and comparing it to its peers can be difficult – even for financial professionals – who don’t necessarily use the same formula for determining a company’s value.
In fact, the methods for valuing businesses varies widely among private equity firms, business brokers, and investment bankers surveyed by Pepperdine. Some use income-based valuations; some use market-based approaches, and some base their determinations on assets. In addition, professionals who use market-based approaches reported using a variety of methods for setting the deal multiples.
These differences resulted in average deal multiples that widely varied. Private-equity firms surveyed reported average deal multiples of 5.5 to 7.5 times EBITDA; investment bankers said average deal multiples ranged from 4.2 to 7.7; and business brokers observed average deal multiples of between 1.5 and 6.
Business owners obsessed with the here-and-now of running a company each day may be tempted to wait until it’s time to sell before considering the value of their business. But if there’s the possibility of an ownership transfer in the future, it pays to continuously think about the value of your company, says Libby Bierman, an analyst with Sageworks, a financial information company.
Accountants can help figure out how much your business is worth now or assist with succession planning that doesn’t involve transferring ownership to outsiders. And regardless of whether there will be a sale in the future, accountants can also coach you on the best way to maximize the value of your business. They can provide benchmarking data and offer tips for addressing weaknesses or for building upon existing strengths.
“Benchmarks can be an invaluable instrument to help business owners know how a company ranks relative to businesses in the same industry or same geographic area,” says Bierman. “How profitable are they relative to peers? Are expenses too high compared against sales or compared with competitors?”
She adds, “Since valuations are often based on cash flow or earnings, improving those should be a high priority.”
After all, wouldn’t you rather find out now that others don’t value your business as much as you do, as opposed to finding out right when you’re ready to exit?