Why Telling a Potential Buyer Your Company's Value is Like Playing Poker Against a Pro with Your Cards Face Up
A business valuation is a tricky matter at best. A valuation professional will calculate the value of a business using a variety of formulas. However, one of the inherent problems of a valuation is that it is typically a mathematical formula and choosing the right numbers to plug in may be like playing roulette. Each business is unique as are its products/services, customer base, market position, and management team. Always remember that the actual value of your company comes down to finding the right acquirer and determining how much they are willing to pay through a competitive process. So if an interested party asks you for a copy of a valuation, does it really make sense to give it to them?
It's no surprise that most business owners tend to overestimate the value of their business when they want to sell. Then there's the other side of the coin - what's going to happen if you undervalue your business? Aside from making a prospective acquirer salivate, your negotiation process is going to be one long uphill battle and there's little doubt you're going to end up with the short end of the stick. So naturally, it makes sense to find that magical number that truly represents the value of your company.
In order to see the problem, let's first look at how valuations work. For most companies with growth less than 20%, a buyer will typically value a company by a multiple times a financial metric (usually EBITDA, but sometimes revenue or net profit). While EBITDA is fixed and buyers and sellers will argue about what discretionary expenses should be included in EBITDA, multiples are much more arbitrary. As an example, let's look at historical selling price-to-EBITDA multiples for private software companies with revenues under $100 million. Approximately 50% of the multipliers fall between 2 and 20 and the remainder are either negative or greater than 20. Even if we focus on the 2 to 20 range, that is an enormous range. If your company has $1 million in EBITDA, that would be the difference between a $2 million acquisition and a $20 million acquisition!
So how does one choose the multiple to apply to your company? Do you use 2, 20, or an average? What if your valuation professional selected the average of the two and reports that your company is worth $11 million? So now, let's give our interested buyer that might be willing to pay $20 million for your company a copy of the $11 million valuation. How much will they pay for your company now? Our magic 8-ball says $11 million. Did your valuation help you? Now, let's assume that our interested buyer is only willing to pay $5 million for your company. How much do you think they will be willing to pay after seeing the $11 million valuation? Probably still $5 million or they'll just walk away. Did your valuation help here either?
When a potential acquirer asks you to provide them with a business valuation or appraisal for your company, the bottom line is: don't do it. If they ask you how much you think your company is worth, give them some high-level guidance, but not a number. Let them perform their own due diligence and determine their own valuation. If you do give them your valuation report, they will look for all weaknesses they can find in the valuation report to convince you the company is only worth their initial offer.
Obtaining a value range from a valuation professional does make sense to understand how much your company might be worth before selling. However, it's only purpose should be used to help you understand the good and the bad of what a third party might pay. The biggest mistake that business owners make when selling a business is they go into the process with unrealistic expectations and waste a lot of time and create a sour taste with companies that could be great strategic partners.
Finally, choose the right professional to give you insight on your value. An appraiser is not the right person to conduct a valuation as they typically only look at hard assets. Accountants can do slightly better but, at the end of the day, they are number crunchers. For purposes of valuing your company in anticipation of a sale, having someone who has a strong pulse on the M&A market may be best suited to tell you how much you might receive for your company.