Selling A Business: How Businesses Are Overvalued
Every business has its price. Drop the asking price enough and chances are you’ll find a buyer from somewhere, so in that sense overvaluation is the biggest obstacle to the successful sale of your business.
Obviously, you first want to maximize the value of your business. But once you’ve done everything you can to make the business as attractive a proposition as possible, you then need to set a realistic asking price.
Too often, however, entrepreneurs who are selling a business fail to set a realistic price – and they rarely go too low. In fact, California-based broker Andrew Rogerson claims: “I’ve never come across a business owner who has undervalued their business; it’s always overvalued, often quite considerably.”
To ensure you set a price that will elicit interest from the market – and this is particularly vital if you’re seeking a quick sale – it helps if you understand how overvaluation occurs. What follows are the most common reasons for inflated asking prices.
- 1. Emotional attachment
As Andrew Rogerson explains, “sellers sometimes think: ‘I’ve been working on this for 20 years so it must be worth a lot of money’ – but it’s really about the cash flow of the business. That comes as a shock to many business owners; they put their heart and soul into the business and think it’s worth a lot of money.”
You can never be truly objective about your business, so that’s why an impartial professional is worth hiring.
- 2. Valuing according to your needs
It’s not unknown for business sellers to inflate their asking price to meet their financial needs post-sale, whether to cover loan repayments and agent fees or to fund their next venture or retirement. But a buyer isn’t interested in your finances – he or she are concerned with the profitability and potential of the asset for sale.
- 3. Poor broker advice
An inexperienced, incompetent or even dishonest agent could overvalue out of a desire to please you and secure your custom. It’s therefore imperative to research prospective brokers carefully, preferably choosing one with experience in your sector and a reputation for competence and fairness.
- 4. Providing incomplete or inaccurate information
An agent’s valuation is only as good as the information he’s working with. So make sure you give him or her accurate and up to date information about your business, including financial records, and be honest about its flaws and refrain from exaggerating its merits.
- 5. Using the wrong valuation method
While profit and loss statements are critical in all cases, businesses are valued using a wide range of formulae, chosen depending on the sector and the particular business’s idiosyncrasies. Broadly speaking, there are three approaches, based on income, asset value or the price achieved for other, similar businesses.
If certain factors are given undue or insufficient weight, then the resulting valuation can be skewed.
- 6. Current owner fundamental to business
Sometimes a business’s success is bound up with its current owner, particularly if there are few staff and the owner plays a major role in designing or marketing the products.
Let’s say a marketing agency has an enviable client roster but 50% became clients because of the owner’s charisma and talent. Basing the valuation heavily on the number of clients would then be misleading because there’d be a real danger of the business haemorrhaging clients post-sale.
This is why it’s important for the seller to plan carefully to minimise disruption during a change in ownership. It might even help to offer to remain in an advisory role after the sale for a certain period, to mentor the new owner and reassure customers that the business will retain its core strengths.
In summary, overvaluation tends to happen when a business is valued for reasons other than its ability to generate an income, or if the seller or broker misjudges its profitability.
Ultimately, the best way to get an accurate valuation is to appoint a broker with experience in your sector and heed his advice – even if it means swallowing your pride and taking a price that neither flatters your ego nor finances a luxurious retirement.