How Much Is Your Business Worth?

 By David Deighton

 Mainstreet Business Brokers, LLC.

 If you own a business, congratulations - because you have chosen the most certain road to wealth in our society. According to the New York Times bestseller The Millionaire Next Door (Stanley & Danko, Pocket Books, 1996), 64% of American millionaires achieved their wealth by owning a business.

SPARDATA, a leading business appraisal firm based in Annapolis Maryland that has experience valuing over 27,000 enterprises, published in 2001 a study of over 2,000 businesses that found owners are often shockingly misinformed about the true value of their businesses.  Every business owner has some number in mind as to what the business was worth.  SPARDATA’s study found owners often misjudge the value of their businesses by 50% or more – sometimes by millions of dollars!  In other words the owner thinks the business is worth $X.  In fact it is never worth $X; it is worth either $2X or $½X.  Unfortunately the owner does not know which – and that can lead to disaster. Two case studies illustrate why.

Risks Of Undervaluation. First let us consider what can happen if you undervalue your business. Let's assume you own a business worth $4 million, but a rule-of-thumb has you believing it is worth just $2 million and your financial advisors have built your financial plan upon that assumption. If you get run over by a truck, your heirs have a big problem.  The current estate tax (combined federal and state) is about 50%, so within 9 months your heirs must pay the government one million dollars. (That is, 50% of the difference between the $2 million you thought your business was worth and the $4 million it was actually worth.) Probably your heirs do not have one million dollars lying around, and so to raise the cash your heirs decide to sell the business. (Too bad if you wanted a family member or a key employee to take over after you've gone.) What is the worst time to sell a business? The answer is: when you have to - when management is in flux and all the likely buyers (namely, your competitors) know the deal must be done under a time deadline of nine months.  Here is a basic truth: if you want to guarantee your heirs sell your business for pennies on the dollar, make sure you UNDERVALUE it.

Risks Of Overvaluation.  Most owners do not get run over; instead they reach retirement age and sell the business, using the proceeds to fund their retirement.  This time let’s assume you’ve overvalued your business – thinking it is worth $4 million but it really is worth only $2 million.  (Personally, if I thought I'd have $4 million to retire on but in fact I had only $2 million, I would like to know that before I hung up the "for sale" sign.

And failure to know what the business is worth can kill your chances of selling for a good price. After you post the for-sale sign, you quickly get an offer for $2 million - a very fair price. But because you think your business is worth much more, you conclude this is a "low ball" offer and reject it immediately. Word gets around that you are asking too much, and offers stop coming in. After weeks turn into months and still no more bids, you begin to worry and finally get the business valued. Too late you realize you should have taken the first offer. But by now your business has been on the market for so long, buyers start thinking it is damaged goods. If you sell for pennies on the dollar, you will be lucky.  Basically if you want to guarantee you sell your business for pennies on the dollar, make sure you OVERVALUE it.

Space does not permit us to consider other related topics such as why “rules of thumb” do not work, and how professional appraisers value businesses.  For answers to these questions make it a point to speak with your financial advisor.  The key point is that owners should find out what their businesses are worth immediately.  Most will not make the effort until it is too late to do anything about it.  And in these cases, ignorance can be very costly. 

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