Why We Don't Prepare "Quick and Dirty" Business Valuations

One of the more common inquiries we receive begins with a simple request.

"Can you give me a quick estimate of what my business is worth? I don't need a formal report. I just want a number."

The request is understandable. A business owner may be considering retirement, buying out a partner, beginning succession planning, or simply wondering what years of hard work have created.

Unfortunately, the answer is rarely as simple as providing a number.

A "quick and dirty" valuation is an informal estimate delivered without the documented analysis, methodology, and professional standards a formal business valuation requires. It can be produced quickly, but it is rarely something an attorney, lender, business partner, or court can actually rely on.

After more than forty years of valuing privately held businesses, I have found that what begins as a "quick estimate" often becomes something much more significant. The value is shared with family members, business partners, attorneys, lenders, or financial advisors. Before long, people begin relying on that number to make important financial decisions.

For that reason, our firm has chosen not to provide what are commonly referred to as "quick and dirty" business valuations.

A Business Cannot Be Valued by Formula Alone

Every privately held business is different.

Two companies may have identical revenues and similar earnings, yet their values can differ substantially. The reasons are often found in the details.

Does the business depend heavily on the owner? Is revenue concentrated among a few customers? Is there an experienced management team? Are profits sustainable? What risks exist within the industry? Are there pending legal matters or regulatory issues?

These questions, and many others, must be answered before arriving at a credible opinion of value.

Financial Statements Tell Only Part of the Story

Many owners believe their financial statements provide everything needed to determine value. In reality, financial statements are only the starting point.

A professional valuation requires analyzing whether the reported earnings accurately reflect the economic performance of the business. Owner compensation may need adjustment. Personal expenses may have been paid through the company. One-time gains or losses, related-party transactions, or unusual business cycles may distort reported results.

Without making these adjustments, the conclusion may overstate — or understate — the true value of the business.

Industry Rules of Thumb Have Their Limits

Business owners frequently hear statements such as, "Companies in your industry sell for five times EBITDA."

While market multiples are useful valuation tools, they are not valuation conclusions.

The appropriate multiple depends on many factors, including the company's size, profitability, growth prospects, financial risk, geographic market, quality of earnings, and the type of buyer likely to acquire the business.

Applying a generic multiple without understanding these factors can produce a result that bears little resemblance to actual market value.

One Number Can Create Unrealistic Expectations

Perhaps the greatest concern with a quick valuation is not the calculation itself. It is what happens afterward.

An unsupported estimate can influence negotiations, succession planning, shareholder discussions, estate planning, or financing decisions. Sellers may reject reasonable offers because they believe the business is worth more. Buyers may question the seller's credibility. Family members may develop unrealistic expectations that become difficult to overcome.

In many transactions, managing expectations is every bit as important as determining value.

A Credible Valuation Requires More Than a Number

A professional business valuation considers the three recognized valuation approaches: the asset approach, the income approach, and the market approach. It also evaluates the strengths and weaknesses of each method before arriving at a final conclusion.

That process requires more than a review of financial statements or the application of an industry multiple. It requires professional judgment developed through education, experience, and careful analysis.

The Cost of Being Wrong

Business owners sometimes hesitate to invest in a comprehensive valuation because they are focused on the cost. The better question is the cost of relying on an inaccurate value.

Whether the purpose is selling a business, transferring ownership to the next generation, resolving a shareholder dispute, supporting an estate plan, or preparing for litigation, the decisions involved are often measured in hundreds of thousands, or millions, of dollars.

Compared with the financial consequences of an unsupported conclusion, the cost of a well-prepared valuation is usually modest.