A poorly executed business valuation can have tragic impacts on business owners.

At an alarming rate, we have been encountering small business owners who have been given unrealistic valuation guidance from trusted advisors and professional firms. This, unfortunately, sets the owner up for massive disappointment and potentially harmful decision-making in one of the most significant events of their lives.

Small (for example, $10M in revenue and below) business owners who want to sell and retire naturally want to understand the value of their company. Most of these business owners want to know the truth. (We stress “most” because there is a certain segment that refuses to accept that valuation is based on return on investment (ROI) and not on reputation and potential.)

These small business owners often find or are referred to advisory firms that do not sell businesses and/or are accustomed to working exclusively on middle market+ sized transactions ($100M+ enterprise value). Now, we are not condemning industry professionals at all; many very high-quality firms and analysts think deeply about the owners’ goals and apply the appropriate methods and resources to the valuation exercise. However, there are many that do not. They often assign smaller clients to junior analysts who use the resources provided to them, combined with theoretical nonsense, to reach conclusions that have no bearing in reality. Since these firms do not need to and do not have any practical experience delivering on their valuation number, it is sadly true that they simply do not understand the data that will be relevant when actually selling said business.

Here is a story, an example of what we run into frequently. 

Interior Design Company Obtains A Poorly Executed Business Valuation

We were recently introduced to the owners of an interior design/home furnishings business. The partners wanted to sell the business and had their business valuation performed by a large valuation firm, one that touted its work for billion-dollar transactions and the Big Four accounting firms. 

This company’s sales were ~$1.2 million. The adjusted EBITDA* figure calculated by the valuation firm was ~$250K for the most recent year. The business has 6 employees.

For the Market Method, whereby comparable transactions are sought out, the analyst from the large valuation firm pulled 7 comps from CapIQ, a database of largely publicly-traded companies. The valuations of the “comparable” companies were the following: 

• $745 million
• $8.6 billion
• $11.4 billion
• $753 million
• $7.7 billion
• $6 billion
• $314 million

Recall that the target company’s revenue was $1.2 million.

The revenue of the smallest “comparable” utilized by the large valuation firm was $700M, or 583x larger than the target company.

This is akin to comparing a 1-man machine shop run out of a pole barn to a $100M production manufacturing business with an international customer base. Other than the fact they employ at least one person, nothing is comparable about these companies. 

The mean EBITDA range determined by the large valuation firm’s analyst was 6.5x – 7.0x EBITDA. The analyst proceeded to concoct fairy tales with a number of additional exhibits in their valuation process.

They used billion-dollar publicly traded company metrics to build an income method model.

They also used revenue multiplier comps, which no buyer or lender would do.

The large valuation firm’s analyst claimed that there weren’t enough smaller private company comparables available to use, which is false (we found 23 in less than 10 minutes). 

It was also determined that three active full-time owners making a combined $225K in salary could be replaced by one manager making $75K. Ultimately, their valuation conclusion was $1.6M – $1.8M.

Now, at this stage, we do not know the actual appropriate range because we have not done the valuation ourselves or had access to the appropriate financial information. However, we have been around the block enough to know that the adjusted EBITDA has likely been inflated by a minimum of $100K – $125K and the multiples for a company with $125K – $150K in adjusted EBITDA are closer to 2.0x.

The Tragedy Of The Poorly Executed Business Valuation

This is a tragedy. Three owners who have likely lived a fine life but have not made a fortune have been told that they may achieve $1.6M – $1.8M for their business when the truth is that it’s much more likely to be $250K – $350K.

That is a significant difference. That is retirement plans, livelihoods, vacation homes, and travel plans upended.

This was all due to a trusted professional either: 1. not having the proper training/resources, or worse, 2. preferring to illustrate an improbable outcome with fancy reports rather than breaking down the hard truth.

Furthermore, once a valuation has been presented, it tends to serve as a psychological anchor for a business owner. When there is a vast divergence between the anchor and reality, it often results in the sale process taking an excessive amount of time or never happening at all; this is all because the owner struggles so much with reconciling what someone told them their business was worth versus the (often) harsh reality of the market.

The Calder Capital Difference

If you were training to be a pilot and had a choice between instructors: one who had studied aviation but had never flown a plane, or one who flew around the world 50 times a year successfully, who would you feel better about choosing?

Before you fly your plane into the sunset, make sure you have an experienced, award-winning mechanic, pilot, and flight crew by your side.

If you are interested in a conservative, well-researched, understandable, and reasonably-priced business valuation delivered by a team of experts who must stand behind their work on the marketplace, please contact Calder confidentially by completing the form below.

At Calder, we don’t just provide valuations; we advise our clients throughout their entire sales or acquisition process. Day-to-day, we engage with buyers and sellers of businesses and are actively informed of market changes. We are well-equipped with the necessary knowledge and experience to provide accurate valuations.

__________

*EBITDA, or earnings before interest, taxes, depreciation, and amortization, is an alternate measure of profitability to net income. By stripping out the non-cash depreciation and amortization expense as well as taxes and debt costs dependent on the capital structure, EBITDA attempts to represent cash profit generated by the company’s operations. EBITDA is widely used as a key component when calculating business valuation.