Many business owners are hesitant to sell their business – what is probably their largest asset – unless a sexy opportunity comes along; for some that opportunity may simply be to get out of the business, and for others it may be to transition to another one. Whatever the case may be, there is a natural conflict of interest between the seller and the buyer regarding price. Nevertheless, one key to selling at a good price is the ability to produce and defend a valuation of the business.
There are many things to be considered when performing a valuation of a business. Often, M&A advisors and investment bankers will use several methods (Discounted Cash Flow analysis, Precedent Transaction analysis, and several other comparable metrics), the combination of which helps to provide a plausible range in which the business could be sold. Note: if you hire a team of advisors, then their valuations alone will not produce a selling price; there are many negotiations involved between buyer and seller, and generally speaking the selling price can be very flexible. However, whatever the valuation methods may be, they help to defend a quoted price and they are also based on important assumptions.
Assumptions are essential in the valuation process. Economists are often criticized for the assumptions they use, but ultimately they help to simplify complexities into variables that can be understood and predicted, ceteris paribus. When it comes to making assumptions to valuate a business, it’s important to understand their limitations; i.e., what can a valuation method say and what can’t it say? Projecting sales growth can be increasingly difficult when past sales have been volatile, for instance, and the smallest change in assumed interest rates can be the difference between a profitable investment and a huge loss. For this reason, a variety of valuation methods are used.
What a seller needs to understand, however, is that they have much control over some assumptions that will be used to value their business. A few examples include: