Top 5 Mistakes Business Owners Make When Assessing Their Business’s Value
Top 5 Mistakes Business Owners Make When Assessing Their Business's Value
Assessing your business's value is a significant step, whether you're planning to sell or simply want to understand your company's overall worth. However, many business owners make common mistakes that can lead to overestimating or underestimating their business's true market value. Here, we'll cover five of the biggest pitfalls to avoid to ensure you get a fair and accurate valuation.
According to CBIZ, a business valuation's applicability heavily depends on the model your practitioner uses. Therefore, it's crucial to select the appropriate valuation method to avoid skewed results.
"Don’t let your flawed business valuation lead to suboptimal decisions." -CBIZ
Additionally, the M&A Source emphasizes that an accurate valuation of a closely held business is essential for assessing both opportunities and opportunity costs as you plan for future growth and eventual transition. This underscores the importance of a precise valuation in strategic planning.
By being aware of these common mistakes and understanding the importance of accurate valuation methods, you can better navigate the valuation process and ensure your business is properly assessed.
Mistake 1: Letting Emotions Cloud Your Judgment
One of the most common errors business owners make is becoming too emotionally invested in their business. It's totally understandable—after all, you've put in years of hard work, long hours, and probably significant sacrifices to grow your company. However, these emotional ties can lead to unrealistic expectations about your business's worth and decrease your chances of selling.
Why It’s a Problem:
Market price valuation is driven by factors like financial performance, market trends, and comparable sales—not by the sentimental value you place on your work. Feeling like your business should be worth more because of the blood, sweat, and tears you've invested won't sway buyers or valuation experts. This phenomenon, known as the "endowment effect," causes individuals to overvalue their possessions simply because they own them. Wikipedia
How to Avoid It:
Take a deep breath and step back, trying to view your business objectively. Consider hiring a professional appraiser who can provide an unbiased assessment based on facts and market data. If you decide to do a Market Price Analysis (MPA) with First Choice Business Brokers, we offer this service entirely free. Of course, you're always welcome to get additional opinions or appraisals, which we will factor into your business listing.
Mistake 2: Neglecting to Prepare Accurate Financial Records
Accurate financial records are the foundation of any Market Price Valuation. If your books are disorganized, incomplete, or full of "creative" entries, it can severely impact the perceived value of your business to prospective buyers.
Why It’s a Problem:
Potential buyers and valuation experts need a clear picture of your financial performance. If your profit and loss statements, balance sheets, and tax returns don’t add up, it raises red flags and can decrease your business’s market value.
"Accurate financial records are not mere bureaucratic obligations; they are a powerful asset for businesses. Beyond compliance, these records serve as a roadmap, guiding businesses toward informed decision-making and sustainable growth. Emphasizing this significance establishes the author’s expertise on the subject." -Accountancy Net
Moreover, disorganized financial records can hinder your ability to secure loans or attract investment, as lenders and investors often scrutinize financial records to assess risk, and discrepancies may raise red flags. Accountancy Net
How to Avoid It:
Ensure your financial records are truthful, up-to-date, and well-organized. Work with a professional accountant or tax consultant to clean up any discrepancies and provide a clear, transparent picture of your business’s financial health. Accurate financial records are essential for making informed decisions, preparing tax returns, and demonstrating financial transparency to stakeholders. Ink Bookkeeping
Mistake 3: Overlooking the Impact of Market Trends
Market trends play a significant role in your business’s valuation, but many owners fail to consider how shifts in the industry, politics, local laws/regulations, or economy can affect their company’s worth.
Why It’s a Problem:
Ignoring current market conditions can lead to an unrealistic valuation. For instance, a business in a declining industry will likely be worth less than one in a growing sector, regardless of its past performance.
"Conditions, such as interest rates and inflation, can affect a company’s valuation. These conditions can also affect a company’s growth potential and cash flow." -Kayone Consulting
Additionally, changes in regulations, such as new laws governing employee pay rates, can increase operational costs, thereby impacting profitability and overall business value. Understanding these dynamics is crucial, as market trends can significantly influence a company's valuation by affecting its growth prospects and profitability. Kayone Consulting
How to Avoid It:
Stay informed about various trends and understand how they impact your industry. Factor in these trends when assessing your business’s value, or consult with a professional who has a pulse on the market. At First Choice Business Brokers, we have been in the business for over 30 years and have witnessed many cycles of businesses becoming more and less desirable. We can help guide you with the timing of your potential sale to ensure you achieve the best possible valuation.
Mistake 4: Failing to Adjust for Owner-Dependent Operations
If your business relies heavily on your personal involvement, with you working 40+ hours covering multiple roles, it can negatively impact the valuation. Buyers are often hesitant to invest in businesses that won’t operate smoothly without the current owner or where they are essentially purchasing themselves a more-than-full-time job.
Why It’s a Problem:
Owner-dependent businesses are riskier investments. If a buyer fears that your departure will lead to a decline in performance, loss of critical clients or contracts, or loss of additional employees, they may offer less or choose not to proceed with the purchase altogether.
"While an owner’s expertise and leadership are often crucial in the early stages of a business, continued reliance can lead to stagnation, reduced growth potential, and decreased market appeal. Your job as a CEO is to get the business to the point where you are no longer necessary to the success and growth of your business." -ValueCap Inc.
Additionally, businesses that are overly dependent on their owners may be perceived as less innovative and less adaptable to change. ValueCap Inc.
How to Avoid It:
Work on creating a self-sustaining business model with adequate staff to handle mundane and specialized tasks. Develop strong systems, processes, and a capable management team that can run the business independently or for short periods while you're away. This will make your business more attractive and valuable to potential buyers and decrease hesitations surrounding a transition. Delegating owner duties and cross-training employees on what the owner does are critical steps to prove to a buyer that the business is not dependent on the owner and that the business can thrive without them. Final Ascent
Mistake 5: Underestimating the Importance of Add-Backs
Add-backs are adjustments made to your financial statements to reflect the true profitability of your business. These can include non-recurring expenses, owner and employee perks, and one-time costs. Many owners either forget to include add-backs or don’t know how to calculate them properly.
Why It’s a Problem:
Not accounting for add-backs can severely undervalue your business and leave money on the table in some situations. Conversely, adding back too much, or errant items can make your valuation look inflated and unrealistic.
"Recognizing and correctly implementing addbacks can make the difference between a fair deal and a lost opportunity." -Acquira
Properly identifying and calculating add-backs is crucial, as they directly impact the EBITDA—a common metric used in business valuation that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA offers a glimpse into a company’s operational profitability. Acquira
How to Avoid It:
Work with a tax analyst or financial expert to identify all legitimate add-backs and ensure your financials accurately represent your business’s profitability. At First Choice Business Brokers, we work with you throughout the entire Market Price Valuation process, ensuring that you get it right. Consulting a professional business broker can assist you in identifying the best way to include add-backs, enabling you to increase the EBITDA and provide a potential buyer with an idea of the business's future cash flow. Forbes
Conclusion
Avoiding these top five mistakes when assessing your business's value will provide a clearer, more accurate understanding of its true health and worth. An objective and well-prepared approach not only facilitates the valuation process but also enhances your company's appeal to potential buyers when it comes time to list the business.
"Proper planning and preparation for the sale of your business can significantly impact the success and profitability of the transaction." -Granite Harbor Advisors
Proper planning and preparation for the sale of your business can significantly impact the success and profitability of the transaction. Granite Harbor Advisors
Receiving a Free Market Price Analysis
If you've been thinking about selling your business, and you would like to get a Market Price Analysis done, the first step is contacting a Business Broker, or other financial advisor who deals with the transactions involved with selling a business. I would love to help get you started if you are interested, you can make some time to meet using my calendar link below.
If you'd rather see some preliminary figures before speaking, please try our new MPA Calculator. This will give you a general price you could expect should you decide to sell. Please be aware that there are many factors that go into the valuation, as discussed in this article, and so we will need to gather all of the necessary documents before providing the documented valuation.
Try the MPA Calculator for Yourself
Explore these expert sources that added to our insights on the topic:
CBIZ. "10 Common Mistakes in Business Valuation and How to Avoid Them." Retrieved from https://www.cbiz.com/insights/articles/article-details/10-common-mistakes-in-business-valuation-and-how-to-avoid-them.
M&A Source. "The Importance of Business Valuation." Located at https://masource.org/education/articles/the-importance-of-business-valuation.
Accountancy Net. "Accurate Financial Records and Business Valuation." Found at https://accountancynet.co.uk/accurate-financial-records.
KayOne Consulting. "Business Valuation 101: Understanding Worth." Used from https://kayoneconsulting.com/business-valuation-101-understanding-worth.
ValueCap Inc. "Owner Dependency: A Business Value Drain." Retrieved from https://valuecapinc.com/owner-dependency-a-business-value-drain.
Acquira. "The Importance of Add-Backs in Business Valuation." Found at https://acquira.com/add-backs.
Forbes. "Understanding Add-Backs When Selling Your Business." Taken from https://www.forbes.com/councils/theyec/2022/02/10/understanding-add-backs-when-selling-your-business.
Granite Harbor Advisors. "How to Prepare Your Business for Sale: 10 Tips for Success." Retrieved from https://graniteharbor.com/learning-center/articles/how-to-prepare-your-business-for-sale-10-tips-for-success.
