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The Madness of Small Business Valuations

The Madness of Small Business Valuations | Selling a Business |

The Madness of Small Business Valuations


The following scenario is all too familiar within the small business sales market;


Decent Business + Genuine Seller + Willing Buyer(s) + Excessive Valuation = Lost (No) Deal


Selling a small business is not always easy, so to burden the process with an excessive and barely credible valuation = one likely conclusion, vendor unhappiness.


These are the primary factors that lead to problems;


1. Sellers Price Expectations


Most sellers have limited knowledge of the business sale process and how to arrive at a valuation. If the seller believes (or has been advised) that their business will achieve X, then they will naturally expect to achieve something close to that number, even if it bears little reality to the market.


Worse still, they may decide to price their business based on what they need to achieve, great if you’re dipping your toe in the water but as an ingredient for achieving a sale ... likely to be a recipe for disappointment.


2. Everyone is an Expert


Business valuation “experts” lurk around every corner. From the golf club to the networking group to the online forum and yet, many of the circulating theories are often detached from the realities of selling a small business.


A proliferation of online guru’s help to create a fog of different theories with some providing advice that could have a negative impact on value.


Below are two extracts of online advice about business valuations – both taken from otherwise excellent websites;


“get a figure in mind and stick to your guns”

“be clear in your own mind about the amount you wish (or need) to realize”


Well meaning if a little misguided, because trying to agree terms based around these criteria is likely to be a route to frustration, as the seller digs in for a price that is simply not matched by market appetite or reality.


3. The Pre-Sale Valuation


We have a mantra about pre-sale valuations – which we repeat until we’re blue in the face (literally) – and that is, for smaller businesses they’re almost pointless. The market will set the price and therefore the priority is to concentrate on increasing the sale value of a business with a combination of good preparation and extensive marketing.


Unfortunately, the excessive valuation is also used by agents as a marketing tool for securing clients - no different from the estate agent beauty parade however, a business valuation contains so many variables that it’s more open to manipulation. All the excessive valuation does is raise expectations for sellers and create barriers to buyers.


4. The Adjusted Net Profit


The adjusted net profit calculation is often a necessary mechanism to help extract the true earnings of a small business. There is often a legitimate debate between parties as to what should be included, so it’s important that the calculation is credible and justified.


This is not always the case as some sellers and advisors include a range of unjustified items that helps to inflate the bottom line and, by using the multiple principle of valuation, over inflate the asking price.


We encountered an example this week. Nice business and keen sellers, but a sale process burdened with an excessive valuation that has been anchored by a silly calculation of adjusted net profit. This valuation has already burned some potential buyers and so, as the price gets reduced, the seller becomes demoralized and the real value starts to decline.


5. What To Do?


People take businesses to market for different reasons and with different expectations. Business owners understandably want to know the value of their business in advance and the larger and more stable a business, the easier it becomes to estimate a potential price range


However, it's a redundant process if you don't focus on driving up the value of your business by concentrating on what really matters;


-Making the business as profitable and sustainable as possible

-Trying to create a management structure that helps to remove the owner operator

-Preparing thoroughly, including some up to date accounts

-Creating as much buyer interest as possible, particularly from strategic buyers

-Generating multiple offers


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