Valuation can be a tricky business

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Oscar Wilde wrote a cynic is someone who “knows the price of everything and the value of nothing” — an idea that business owners should keep in mind when they decide to sell.

Valuation of a business in preparation for sale can be more complicated than owners expect, says Robert Bezede, a director of Norton McMullen Corporate Finance Inc. in Toronto and an advisor for small and medium-sized businesses.

For some of those whose wealth is tied up in their business, their exit expectations may be unrealistic.

“There can be a lot of false expectations — kind of reverse sticker shock, where people take their businesses to market and find there just aren’t a lot of buyers,” he says.

This happens because, “there are a number of factors that some owners don’t consider at first. Everything from the size of their business, to how involved they are as owners to the risk in their industry and the concentration of the customer base. You have to do research and prepare your business for sale,” Mr. Bezede explains.

Buyers sometimes overvalue the businesses they seek to purchase too, says Mike Finger, transition advisor and founder of Exit Oasis, based near Minneapolis-St. Paul, Minn.

“It tends to be a function of optimism. I see buyers who think: I’ll keep doing what the business is doing already and it will get better.’ This is an idea that I’m seeing in the market right now, with the pandemic having affected businesses,” he says.

It’s rare for owners to undervalue their businesses and sell them for a song, although it does happen, says Eric Gilboord, CEO of Warren Business Development Centre Inc., which works on business transitions.

For instance, there is the case of Burt’s Bees, which ended up netting its co-founder Burt Shavitz US$4 million but which became worth hundreds of millions after being acquired by of the Clorox company and now sells an estimated one stick of lip balm every second.

“My understanding is that that was an exceptional situation,” Mr. Gilboord says. In the rare cases where businesses are undervalued before they are put up for sale, it can be because the seller didn’t anticipate how the business would grow after a new owner has acquired it — think, for example, of the McDonald brothers in California when they had one hamburger stand. The iconic golden arches are now a global phenomenon (which made the McDonald brothers a lot of money when they sold their remaining stake, but nothing near what the company is now valued at).

Transition experts

One thing both prospective buyers and sellers can do to assist them in their deals is to consider a transition expert who specializes in their particular business.

“There are pros and cons to this, of course,” says Victor Harding, president of Harding Security Services Inc., which specializes in working with alarm and security companies that seek to buy, sell or merge. The disadvantage is that using a specialist might narrow the field of prospective buyers; the advantage is that the expert knows who will likely be serious.

A specialist will understand as well which prospective purchasers know what they want to do with companies in their own sector that they acquire.

“I can also help move along the deals, which is important,” Mr. Harding notes.

“Sometimes people think there’s such inherent value in the deals they’re making that they think they’re going to happen on their own, but as an intermediary who knows their business I can explain the value of getting it done in a timely fashion,” Mr. Harding says.

Even specialists have to broaden their horizons, he adds. “I started with home security companies, but to make a living, I have to know about fire prevention, security guard services and so on,” he says.

While it can be imperative to move a business transition forward in good time, it’s also important to be patient with prospective buyers, Mr. Finger says. Sellers need to do two things, he says: give the owners enough time to evaluate what they’re interested in buying, and be forthcoming with details about the company and its business.

“Buyers are going to be spending 90 to 120 days analyzing your business before they decide to buy it, and if you’re the owner, you have a full-time job while they’re doing this. And that job is making sure they have the information they need.”

Often a lot of the most important work happens even before the business goes up for sale, says David Prowse, certified business valuator and principal of Velorum Business Advisory in Burlington, Ont.

“We try to help the businesses we work with improve their cash flows [before going up for sale] and we try to de-risk the business [minimize the business risks]. Doing those two things helps create a higher valuation,” he says.

Business owners should not simply assume that because they think their business is valuable — even if it does have value — that others will agree, Mr. Finger says.

“There are a lot of ugly babies out there. I have seen numbers showing that 80 per cent of businesses that are put up for sale won’t sell,” he says.