Wednesday, April 20, 2011

Three Business Valuations Myths by Mark Tygart

The Discovery Channel has a program called “Mythbusters” which seeks to debunk mythology dear to popular culture but that is baloney. In a similar spirit I offer the following valuation myths, desperately believed by business owners but upon examination as likely as a Loch Ness Monster or Bigfoot. 


Myth #1: Valuations determine the monetary value of a business for sale.

Absolutely not! The buyer ultimately determines the value of a business, as it determines the value of everything within the economy. The buyer may get a deal or may pay too much, anyone reading the business press can watch this happen every day. M&A professionals do not typically post a price of a business for sale, they simply contact buyers and wait for offers. The valuation is only an intelligent approximation of fair market value; smart intermediaries often use a variety of valuation methods and indicate a range of values.

The Valuation exercise is for the internal use of the intermediary and the client. The central exercise is to have the company’s financials “recast” to appear as they would if this were a public company, but this really is an exercise in proper accounting, not valuation, and is generally not subject to argument. 

Myth #2: The Valuation will convince the Buyer to pay a fair price.

Wrong again! The buyer will make his or her own estimation of value that will with goodwill comprise their offer for the business. The seller’s valuation is regarded as suspect by definition. The key figure is usually EBIT or EBITDA, which in layman’s terms are simply the amount of money the business has made over a recent historical figure. That and the stability of these financials coupled with the industry in which the business operates will determine the offer the vast majority of the time.

This is why properly audited financials are so important, good buyers run for the hills when confronted with shoe boxes or numbers scribbled on cocktail napkins. Wouldn’t you? 

And Another One…

Myth #3: The Value of my Business represents the Value of my Life.

This is usually the central problem a deal professional has to deal with in a valuation dispute with a client. It is usually unspoken and may not be consciously understood. As a valuation of anyone’s life work any rational economic number will fall short. However, some sense of personal vindication is usually lurking in the mind of the business owner when he or she reacts with outrage to an internal indication of value that will never be shared with the market and will not determine the value of the offers that the business receives. 

The idea that a valuation is more than a valuation is the greatest myth of all.