Why Industry Multiples Can Be Dangerous When Valuing a Business

Whoops!

I meet with business owners on a regular basis. At the very heart of most of our discussions is the elusive question of “How much is my business worth?”  For years they have poured sweat equity into their vocation, possess an enviable customer list and are well versed on their competition. In the back of their mind someone told them about how “the guy down the street sold their business for 2.5 times EBT”.  They do some quick math and decide they could be happy with that price. What’s the harm?In all cases I refer them to a qualified professional that can complete a comprehensive business valuation. I do this for two reasons.  First, as a broker, I earn the trust of the business owner to open up their financials and the privilege to market their business to qualified buyers.  I never want a business owner second guessing the asking price, especially one I recommended.  I have found that a professional valuation keeps the discussion at arms length rather than speculating a hidden agenda exists.

The second reason I recommend a business evaluation conducted by a third party is that it takes the emotion out of the equation and allows the business owner to make an informed decision based on facts. Sure we could do some math on the back of a napkin and get a “ballpark” number for the price of the business. Many of the owners I deal with have a command of the facts and know the industry very well. However, they owe themselves more than an instinct or guess when setting a price for their business. They have worked too hard to simply leave money on the table by setting a price too low. If they guess on the high side, they will be consumed with the selling process and frustrated with buyers that show interest and then back out of the deal late in the game.

Occasionally I have a confident business owner challenge me on the necessity of a business valuation. It is tempting to take their number and run with it. No skin off my neck right? Wrong! A business valuation is more than taking an industry multiple and deciding on a fair price. Over the years I feel I have developed a feel for what the market will value a business. Recently I was humbly reminded that I was no expert in business valuations. During our discussions and my own research prior to meeting with the owner I felt I had an accurate gauge. I floated a number and the owner agreed that it was a fair price and they would be pleased with that price.

Fortunately we continued down the path of having an expert prepare a business valuation for this business. Two weeks later the valuation came back $125,000 over my recommended price. There is nothing wrong with running the numbers to get a feel for what a business could be worth. When it comes time to actually sell the business, do not short change yourself and let a professional determine the proper price.