One of the most interesting and befuddling issues we encounter when we meet with prospective clients is this: They all think they know what their companies are worth. However, very few, in fact about zero, have paid for a professional evaluation on the business. So how can they claim to know what the business is valued at?
Here are some methods we have come across:
Lest you think I am making these up, trust me, I am not. These are valuation methods (along with dozens of others) that we encounter all the time at our M&A conferences.
Are they valid? Do they support your goal of obtaining the highest possible value from your largest investment of capital and time? Most likely they are not the optimal way of determining a business’s enterprise value (BEV).
Yet uninformed business owners over and over and over again make the same mistake and approach buyers with a number in their mind that is not based on any credible valuation methodology. Make no mistake, buyers love this. They are not responsible for helping you get the most for your retirement. Their goal is to generate the highest internal rate of return (IRR) that they can to make themselves look outstanding to their executive staff.
Even though your Cousin Larry probably does not answer to anyone when he buys your company, chances are good that his valuation method is likely not based on pure science either.
So what do we recommend? First, don’t go it alone; you might get lucky and find a buyer who will give you a premium for the business and a great deal structure to boot, but the odds are pretty low. Here is what we suggest:
This last point is very, very important. Let’s be real: Entrepreneurs typically have large egos (they have to in order to survive as business owners). To make matters worse, far too many have their personal identity all knotted up with the company they founded (or worse yet the company their great, great granddaddy started), so when they hear a number below their ego’s expectations, they often overreact.
Keep this in mind:
Your businesses BEV might not be what a willing and informed buyer will pay for your company.
Why? Because the BEV is based on economics; your recast earnings are projected forward based on an assumed growth rate and they are “discounted” back using complex mathematics to come up with an “economic” valuation (this is the discounted cash flow method of valuation). This number is then often benchmarked using several other valuation methods to verify its economic accuracy.
But what the market may pay could be far different. Why? Synergies! And this is where a fantastic dealmaker can make a huge difference, which is another key reason to hire an M&A advisor like Generational Equity – at the end of June we celebrated the closing of our 500th transaction. How many deals have you closed? Enough said.Experience is priceless!
So it is vital that you avoid the sixth mistake outlined here: Know your company’s BEV long before you approach buyers. Otherwise you may be accepting an offer far from its economic value, a fact that savvy buyers simply will not point out to you.
I have barely scratched the surface on this mistake and I have used a bunch of terms that you may not be familiar with (BEV, IRR, recasting, etc.). Really, the best way to find out how to avoid this mistake (and all the others we have covered in this series) is to invest a day and attend a Generational Equity M&A conference. You will be amazed at what you learn!
And the knowledge you gain will keep you from making a boatload of mistakes.
Interested? If so call me at 972-232-1125 or email me at email@example.com. In closing, listen to what a few of our clients learned at our seminar and avoided the biggest mistake of all: Not hiring an M&A advisor.
Carl Doerksen is the Director of Corporate Development at Generational Equity, part of the Generational Group.
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