The value of your business? Write down your estimate. Then pose the question to your closest friends and advisors. You’ll be amazed at the range of responses.
For further amusement, ask each person how his or her answer was determined. Though value and valuation are fundamental to our economic lives and free-market system, the concepts are misunderstood and constantly misapplied.
Only a precious few possess a true working knowledge of valuation, and from these few come the capitalists who earn 99% of the income. They do so by combining their knowledge with risk capital and putting both to work. The personalities are on the front pages of our newspapers and financial magazines.
Why is business valuation shrouded in confusion? Amazingly, our high schools and colleges really don’t teach it – outside of basic microeconomic theory. And, contrary to common belief, the basic curriculum for accountants and attorneys doesn’t include business valuation. Most graduate business schools cover only the valuation of publicly traded securities, and many people are surprised to find that bankers aren’t trained in business valuation, and they almost never look at business value when assessing a loan. Aside from the shortage of clear education on the subject, valuation — and business valuation in particular — has some characteristics that foster confusion.
Value is Subjective
Valuation is not exact, but rather subjective. It’s like beauty; as they say, “Beauty is in the eye of the beholder.” What is the value of the watch on your wrist? The diamond ring your spouse gave you? The value of the 1971 Lincoln Continental sitting in your backyard, unprotected, for the past eight years? It was your father’s last car and his prized possession. Your answer will be much different than someone else’s.
Few People Are Exposed to Factual Business Sale Data
The fact that so few of us own businesses means few experience the purchase or sale of a business firsthand. Businesses are not bought and sold as frequently as real estate or cars – and when they are, the data are both complex and protected as confidential. Conversely, real property sales are almost always made for cash at closing, and the price is of public record (automatically recorded at the county government level).
High Interest + No Factual Data = Misinformation
People are immensely interested in people and money – and business sale transactions involve both. Third parties naturally want to know who and how much. Credible data are often unavailable, so the void is filled quickly by misinformation circulating as fact. Add to this the fact that buyers or sellers may allow or even seed false data to paint him or her in a favorable light.
Complexity of Biz Sale Transactions
Unlike cars and houses, businesses usually don’t sell for 100% cash at closing. It’s very common for the price ultimately to be contingent on events that occur after the date of sale. The portion of a purchase price not paid at closing is referred to as “terms.” As such, the actual sale price is often very difficult to determine. In these cases, the actual sale price can be determined only after all contingent events occur and the “terms” payments are calculated and paid.
Every Business is One of a Kind
Most things we buy have very close substitutes. Even a house and used car can be considered to have close substitutes. This makes the task of valuation much simpler. We can compare one to another and sale price history. In contrast, almost all businesses are unique. They rarely have close substitutes. Applying the “comparable sales” method is much more challenging.
The next time you hear someone say, “Jimmy sold his business for X,” take it with a grain of salt. It’s entirely possible that even Jimmy doesn’t yet know the price he received. –David L. Perkins, Jr.
Image by Stuart Miles