Market Valuation Mistakes
Thanks to owning his own auto body supply business for 14 years and owning a printing business for eight, Marc Gudema, owner and partner at BayState Business Brokers has experience in several industries, selling business with revenues of anywhere from $1 million to $10 million.
Whether you’re beginning the succession planning journey or are interested in selling your business, Gudema says knowing what your business is actually worth is frequently misunderstood.
He walks through the types of market valuation and some common mistakes that can be made when understanding the value of your shop.
1. Lack of knowledge.
People are just not familiar with the process and they’ll have heard some rule of thumb from somebody that’s just off the mark. This may come from not understanding the different approaches to market valuation, specifically if a third-party were to appraise the business.
On a basic level, here are two approaches you should know:
Income approach: This approach looks at separating the owner from the business. Let’s assume that we count all the income and benefits to the owner and we add that up. A lot of the time, if the business is profitable, they will take benefits, such as a company car, a pension plan, some travel-related expenses, etc. We add all that up and then take out what we would have to pay a manager to run the business and see what the profit would be pre tax. Using that, we either look at what kind of return on investment we want or what type of discounted cash flow analysis.
Market approach: We typically use this approach. This approach looks at what these businesses sell for. We look at two different metrics: top-line revenues of the business and all the income and benefits to a working owner. We have databases where we look up the particular type of business. You look at how the particular shop has done, typically, in the last full year. We use tax returns because that’s what the buyer’s accountant and lenders prefer to look at but we will do what is called recasting. For example, when a return says there are $15,000 worth of automotive expenses, when $7,000 of that is the owner’s car and his wife’s car, which they're not really using in the business, we add that to the list of add backs. Then we will give the seller an estimate for what the business is likely to sell for.
2. Over-valuing your equipment.
It’s not unusual that owners over value their equipment, so when looking at what your equipment is worth, get a third-party evaluation. Take the asset approach when valuing your business. This approach is where you would evaluate what the business would sell for if you just liquidated the assets. Typically the business appraiser would get the equipment valuation from the equipment appraiser.
The equipment is included in the value of the business, not separate. In the income and market approach, the numbers that you come up with will include the equipment of the business.
3. Not establishing a good reputation.
A good reputation and community presence has value. If you go to a business appraiser with that belief, they’ll say that value is determined by how much profit you make, not goodwill.
4. Thinking “money off the books” is OK.
Businesses that have a significant amount of money off the books (jobs that are not formally documented) are not good for selling. Owners feel that the buyer should pay them for that undocumented work. It also becomes problematic for the lenders that are going by the tax returns because if the returns don’t show that you are making money, or making enough money to support the sale price, they’re not going to approve the loan.
5. Not creating a diverse business.
Customer concentration can hurt the value of the business. For example, if you’ve got two DRPs that are the entire business, that might decrease the value of the business or a buyer might want an earnout (when some of the purchase price is paid afterward based on retaining the business). This is done because if the new owner were to lose one of those DRPs halfway through the year, the value of the business decreases. Same applies if they had a big fleet account.
Work force also counts. If an owner is ready to retire and some of the employees are also near retirement, the buyers will have to go out and find new people. If you have too many family members in the business, it’s the same sort of issue in terms of finding replacements.