Are you trying to build a business to one day sell for top dollar? If so, it is critical for you to manage your value expectations and to be aware of how your business will be perceived and valued by potential purchasers.
Many business owners have unreasonable expectations regarding the value of their business. According to RBC Business Succession Planning: Your Essential Roadmap, "It is important to get a professional business valuation, since owners may grossly overestimate or underestimate the value of their business."
Some business owners overestimate the value of their business and others actually underestimate the value of their business. I have seen both situations before and there are serious implications to erring on one side or the other.
Implications of Overestimating Value
Business owners that overestimate the value of their business may do so because they place too much emphasis on sweat equity or they ascribe value to the personal goodwill associated with the business. Sweat equity refers to the effort and time put into the business and personal goodwill refers to the value associated with the personal skills and abilities of the business owner which are not commercially transferable. A potential purchaser will not be willing to pay for the business owner’s value expectations if the company financials do not support them.
A potential purchaser is interested in future cash flows. When the target’s cash flows (current or future) do not support the business owner’s value expectations, this creates a (potentially significant) gap between what a potential purchaser is willing to pay and what the business owner expects to receive. The larger this value gap the greater the risk of not getting a deal done.
Implications of Underestimating Value
Business owners that underestimate the value of their business may do so for many reasons. They may not understand how a potential purchaser values a target company. They may not appreciate the value associated with various intangible assets they have created (e.g. customer relationships/contracts, intellectual property, proprietary technology, goodwill, etc.). They may have based their value expectations on outdated or inappropriate industry rules of thumb.
A potential purchaser may see value that you were not aware existed, especially if you are dealing with a strategic purchaser.  The price paid in an actual transaction is the result of a negotiation and a potential purchaser will rarely put forth their best offer initially. If you are not armed with the ability to understand and justify the value of your business to a potential purchaser you run the risk of leaving significant money on the table. You may be inclined to accept an initial unsolicited offer without attempting to negotiate a higher price based upon valuation principles and valid assumptions.
The consequences of overestimating or underestimating the value of your business can be severe. An independent business valuation conducted 3 to 5 years prior to sale allows you to manage your value expectations and enter meaningful negotiations with a potential purchaser, provide reasonable justification for your value, increase your chances of getting a deal done and not leave money on the table in the process.
Contact us at firstname.lastname@example.org or www.vspltd.ca if you want to manage your value expectations and minimize your risks with an independent business valuation.
1. A strategic purchaser is one who believes it can enjoy post-acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with its own.