Recently I read an article in “Inc.” magazine espousing why a business valuation is less than important (http://www.inc.com/david-lonsdale/why-a-valuation-is-less-important-than-you-think.html). Then a week later in “Forbes Magazine” is an article stating that to build value you should value your business (http://www.forbes.com/sites/steveparrish/2012/08/14/if-you-value-your-business-you-should-value-your-business/).
What gives? Well let’s look at both authors’ points:
In the first article above, the writer, and the President of a lower middle market investment firm, makes the following arguments against a business valuation when starting the process of selling your company:
1. That your business value fluctuates over time along with your revenues, profits and the future industry outlook. As soon as these qualities change, your valuation expires.
2. That a buyer is not concerned with your professionally prepared valuation because they will determine value for their own purposes. Therefore, investing in a valuation to defend a starting point for negotiations is also of little value.
3. That, in the end, your business value is based on what a buyer is willing to pay, so why should you bother valuing your business when the market makes the determination, ultimately.
The writer supports these arguments by describing a deal in which a company he represented sold for many times more than the industry’s average price per earnings. In this example, the writer’s firm found a highly motivated “strategic buyer” and leveraged their unique interests in his client to drive up the price.
In the second article above, the writer opens by quoting Warren Buffett, “If business schools could offer just one course…[it] should be encouraging students to learn the boring, but critically important, discipline of business valuation.” This writer, an experienced attorney, and financial planner, supports Mr. Buffet’s statement in the context of the student being the owner of a privately held business.
The writer contends that an owner will inevitably face the question of their business value someday. This could be for a sale, death and estate taxes, or any number of opportunities and potential threats. Therefore, an owner applies sound judgment gaining an understanding of basic valuation principles and how they apply to the owner’s specific business. This of course is delivered to the owner by a professionally prepared valuation.
These opposing views leave us with the question of: How do you assess the value of a business valuation?
At the heart of any valuation is the question of risk. A business appraisal seeks to measure in dollars the risk and reward of an investment. An owner should also apply the same principle to investing in a business valuation. What are the risks and rewards of an investment in understanding your business value and the fundamentals behind that value?
That is a question that can only be answered by each individual business owner, but here is some food for thought…
Risk Tolerance 1: Do you like surprises? It is common for the emotional attachment an owner has to their business to give way to an over-inflated perception of value. This leads to implementing future financial plans based on a false assumption. Once this is realized, it’s too late to do much about it. As an owner, would you prefer to make your financial plans conservatively, or take the risk you will end up disappointed?
Risk Tolerance 2: Are you proactive or reactive? A certified business valuation reports on all the strengths and weaknesses specific to the subject business. Knowing these factors gives an owner the opportunity to take specific actions to reduce risks and improve the value of their business.
In the first article above, the “strategic” price paid comes from knowing and defending a unique competitive advantage in the marketplace. Many owners can only flesh this opportunity out by having an objective analysis of not only their business, but also their competitors, industry and economic forecast – all of which a certified business appraisal addresses.
While these conditions can change unexpectedly over time (reactive), they can also be exploited with advance knowledge (proactive). In other words, assessing in advance a potential competitive advantage highly sought by a strategic acquirer, could give an owner the opportunity establish, prepare, protect and defend just such a tremendous value driver in the future.
For every owner, the conclusion is that they determine the value of a business valuation. This value should not be based on the opinions of others, but on their own tolerance to risk. For some, an investment in a business appraisal – their own education of general business valuation fundamentals and their specific business value – makes sense. For others, maybe not.