July 15 , 2019

Mistakes To Avoid When Valuing Your Business

Business Valuations – although neglected by many– can you give business owners valuable insight into their business operations and net worth. It’s extremely important that you have a business valuation performed at various stages in your business’ lifecycle but also that you can rely on the results with some high level of confidence.  Over the years, I have seen some mistakes in reports I have reviewed.

Here are some common mistakes to look for in Atlanta and Sandy Springs, GA valuation reports:  

1.Accounting for Assets and Liabilities correctly

Each of the three main valuation approaches to business valuation (income, market, and asset) is designed to calculate value based on cash flow generated by the operating assets of the company. Liabilities must be considered when calculating an Enterprise Value. Business owners need to make sure the model (s) provided by their business valuation expert addresses the following, among others discussed later:

  • Non-operating assets –Things like excess cash, loans to shareholders, etc. should added back to overall value.
  • Off-balance sheet liabilities – These impact equity value whether on balance sheet or not if the company and owners are legally liable for paying them
  • Level and treatment of risks – There is an inverse relation between risk and value. A good report will detail what risks are being considered and why.

2. Risk in projections

Any business growth that is assumed should also be supported. All assumptions should be supported by detailed reasoning based on not just historical performance but forward thinking about the market, industry, economy, opportunities, and risks.  The business valuation expert in Atlanta or in any city should work closely w/ management to reconcile his/her projections against theirs. If those estimates vary significantly seek to understand why and make documented adjustments. Some things to consider: capacity, short term vs long term growth rates, variable vs. fixed expenses, inflation, etc.

3. Overreliance on unsubstantiated multiples – we see this a lot!!!

Multiples vary over time and from business to business within an industry. High-level multiples published – “4X EBITDA” or “1X revenue” cannot be applied across the board to any company in an industry. However, they are a form of market-based valuation and can be looked at for overall reasonableness in the derived values in a business valuation report.  

A sound business valuation must factor in growth, location, competition, debt levels, operational efficiencies, and many other factors. Rough estimates should never override sound research and analysis.

4. Blindly using comparable transactions

Comparable transactions should be selected from valuation databases based on industry (SIC/NAICS codes), revenue levels, cost structure, region, transaction date, etc. There is so much additional analysis that needs to be done before deciding on valuation multiples. In addition, make sure numerators (Equity vs. Enterprise Value) and denominator (EBITDA, Discretionary Earnings, Net Income, Cash Flow) match for comparable companies and your business. Business Valuations can run awry when they rely on too much comparable data that hasn’t been scrubbed and compared. At a minimum, your business valuation expert should perform additional analyses to show how your business compares to the comp.

5. Mathematical errors

Hopefully a reputable business valuation report won’t have any but math errors can have a huge impact w/ rippling effects. ‘Nuff said!! 

6. Mismatching capitalization and discount rates with measures of economic income

Capitalization and discount rates convert a series of present and future anticipated cash flows, respectively, into present-day business value. However, rates created for one income stream can get applied to another one by mistake and you must have numerator and denominator defined the same way – i.e., you don’t want an after-tax measure to be applied to a pre-tax measure. Good Business Valuation experts make sure this won’t happen.  

These rates reflect the risk inherent in the cash flows based on company size, stability, market, and other company specific risk factors. Cash flows to equity holders are lower than cash flows to invested capital, which includes both equity and debt holders. However, the capitalization and discount rates will be higher for equity investments and lower for the firm as a whole. Applying a capitalization/discount rate to the wrong measure of economic benefit can result in a material misstatement of the business value.

If you think any of these mistakes, are present in your business valuation, ask about it and maybe get a second opinion. A flawed business valuation can lead to poor decisions that can have far reaching impacts.