Most business owners do not have a realistic idea of what their businesses are worth. Owners almost always think that their business is worth quite a bit more than the market would likely bear. There are several reasons for this.
1. Emotional Ties: Owners are personally and psychologically tied to their business.This is particularly true for long-running family businesses.
An owner has poured their heart and soul into their business. Where others may see a mundane business, owners - like proud parents, see their business as an apple of their eye. This emotional tie may cause a disconnect with the realities of the market.
2. Lack of Analytics: Most small business owners do not have a grounding in the analytics which determine a company's value.
Sadly, I have run across several owners who negotiated a purchase price for their businesses with their gut, and ultimately overpaid. Now, they are hoping this is the baseline for the current valuation. Not surprisingly, this is not a criterion for prospective buyers. Most buyers value a business based on its cash flow. The original purchase price rarely - if ever, is a factor.
3. Needs-Based: Some owners reverse engineer the value of their business based on the amount they want/need.
This is a bit like the tail wagging the dog. A knowledgeable buyer certainly won't over-pay for a business in order to fund your retirement.
4. Unproven Success: Early stage or high -growth companies may not have proven their business model yet.
Remember, in most cases small businesses are bought based on historical performance, not projections. To profit from investments made to grow the business, you should count on three years of sustained performance at the elevated levels.
At the end of the day your business is only worth what a buyer is willing to pay. Absent that, a formal valuation not only helps to set expectations, but also educates the owner on the variables which impact value.
While getting a valuation which is significantly less than one had hoped can be very discouraging. However, recognizing the factors driving value can also be empowering. And, positively influencing those factors can lead to a higher valuation down the road.
