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The 5 Biggest Mistakes Made When Getting A Business Appraised

Garry Stephensen

Article Author: Garry Stephensen
Position: Managing Director
Read time: 6 mins

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Most business owners will, at some point, want or need to know how much their business is worth. They will be faced with the task of finding someone to perform a business appraisal or valuation. Since this is unfamiliar territory, the owners often make some big mistakes.

Mistake #1 - Automatically hiring your existing CPA firm

Business owners often assume that all CPAs are competent in business valuation. In fact, many CPAs have very little or no business valuation experience or training. Don't expect your CPA firm to tell you if they are not proficient in this area. Firms are often reluctant to; turn down additional revenue, admit their lack of expertise, and refer you to a competitor.

Ask your CPA firm if they have any staff that are credentialed and experienced in business valuation. Then get an anonymous list of their prior business valuations by business size and type. Don't be too concerned if they have not valued a company in your same industry. Regular and recent business valuation experience is much more important. If they don't have adequate business valuation experience, ask if they would recommend a firm that does.

Mistake #2 - Automatically hiring a referred professional

Referrals mean different things to different people, so you must ask on what basis it is being given. If it based on a brief meeting at a networking event, then don't give it much weight. Referrals based on reputation alone are only slightly better. Seek referrals based on first-hand dealings with the referred professional. All referrals, even high quality ones, need to be evaluated further to determine their business valuation competence.

Mistake #3 - Using rule of thumb formulas

Many business owners believe there is some secret formula that can be used to accurately value their business. There are many rules of thumb and they are not a secret. Rules of thumb can be useful to get a "quick and dirty" estimate, but they have some serious flaws. No one really knows the quality and the quantity of the data on which they are based. The formulas typically use multiples that are expressed in ranges (like 1 to 2 times annual sales) that result in widely varying values. The formulas provide no guidance on how to select an appropriate number within that range. Most importantly, these formulas do not account for the unique characteristics and factors that affect the value of a specific business. If a business valuation will be given to third parties or subject to dispute, rule of thumb formulas just won't stand up to the scrutiny.

Mistake #4 - Paying too little

Business valuations typically cost thousands of dollars. In an attempt to save money business owners often look to get one on the cheap. There are a number of sources on the Internet that will value a business for substantially less cost. The old adage - you get what you pay for - applies here. These services use various formulas, proprietary data, checklists, and etc. to arrive at an estimate. Some even come with rather impressive looking reports. In general, these services are just high-priced, dressed-up rule of thumb formulas.

Mistake # 5 - Paying too much

Business valuation firms often set minimum fees and limit the levels of service without regard to the cost restraints of smaller companies. By omitting some valuation procedures that typically aren't relevant to smaller businesses and preparing summary-style reports, firms can legitimately and significantly reduce the cost of a business valuation. A high cost, full scope business valuation is often overkill for a small businesses. Look for a firm that can match your needs more closely to save money. Fees can vary greatly so it pays to shop around. Seek the best professional for the best price, not necessarily the lowest price.

By taking the time to do some basic research business owners can avoid these mistakes, hire a competent business valuation professional, and get the most value for their money.

As seen in the Financial Review and the Courier Mail.

Can a Business Owner Value Their Own Business?

Attempting to value a business without professional assistance presents several significant risks and limitations, potentially leading to serious financial and legal repercussions.

Firstly, business valuation is a complex process that requires a deep understanding of various financial principles, methodologies, valuation multiples and market conditions. Without professional expertise, a business owner may rely on overly simplistic formulas or rules of thumb, which can lead to inaccurate valuations. These methods often fail to consider unique factors such as the company's market position, competitive landscape, or specific operational efficiencies and risks. Consequently, the valuation derived might be significantly off the mark, either undervaluing or overvaluing the business.

Financially, an incorrect valuation can have dire consequences. For instance, if a business is undervalued, the owner might sell it for far less than its true worth, resulting in substantial financial loss. On the other hand, an overvalued business might deter potential buyers or investors, leading to missed opportunities and prolonged periods of liquidity issues. Moreover, if a business owner seeks financing based on an inflated valuation, they may face difficulties when the business fails to meet the expected performance metrics, potentially resulting in loan defaults or damaged creditworthiness.

The 5 Biggest Mistakes Made When Getting a Business Appraised

Legally, an inaccurate business valuation can lead to disputes and litigation. If the valuation is used in a transaction, such as a sale, merger, or acquisition, and the figures are later contested, the business owner could face legal challenges from disgruntled buyers or partners. Additionally, in scenarios such as divorce settlements or shareholder disputes, an improper valuation could be legally contested, resulting in costly legal battles and potential penalties.

In summary, the risks and limitations of valuing a business without professional help include financial losses from incorrect valuations, missed opportunities, difficulties in securing financing, and potential legal disputes. Engaging a professional ensures a thorough, accurate, and defendable business valuation, mitigating these risks and safeguarding the business owner's financial and legal interests.

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Benefits Of A Well-Conducted Business Valuation

A well-conducted business valuation is a critical tool in securing investment or loans, as it provides a credible and data-driven assessment of a company's worth. This credibility reassures potential investors and lenders about the business's financial health, growth potential, and risk profile, which are essential factors in their decision-making process. Here's how a robust valuation can aid in securing funding:

1.  Credibility and Trust

 A well-conducted valuation, especially one performed by a reputable and experienced professional, carries significant weight. It demonstrates that the business owner is committed to transparency and accuracy, which builds trust with investors and lenders. These stakeholders are more likely to invest in or lend to a business that provides a clear, professional, and thoroughly vetted valuation rather than one relying on vague or unverified figures.

2. Comprehensive Financial Picture

A detailed business valuation encompasses a thorough analysis of the company's financial statements, market position, competitive landscape, and growth projections. This comprehensive picture helps investors and lenders understand the business's current financial health and future potential. It provides insights into revenue streams, profit margins, cash flow stability, and other critical financial metrics, enabling stakeholders to make informed decisions based on a solid understanding of the business's financial standing.

3. Risk Assessment

Investors and lenders are inherently risk-averse and seek to minimize their exposure to potential losses. A rigorous business valuation includes an evaluation of various risk factors, such as market volatility, competition, regulatory changes, and internal operational risks. By quantifying these risks and demonstrating how the business is equipped to manage them, the valuation report can reassure stakeholders about the company's resilience and risk management capabilities. This risk assessment helps investors and lenders gauge the safety of their potential investment or loan.

4. Accurate Valuation Metrics

Investors and lenders rely on specific financial metrics and ratios to assess the viability of their investment. A well-conducted valuation provides precise figures for metrics such as the price-to-earnings ratio, return on investment, debt-to-equity ratio, and more. These metrics help stakeholders evaluate the business against industry benchmarks and peers, making it easier for them to determine the attractiveness of the investment or loan. Accurate valuation metrics also support negotiations by providing a solid basis for discussing terms and conditions.

5. Strategic Insights

Beyond numbers, a detailed valuation can offer strategic insights into the company's strengths, weaknesses, opportunities, and threats (SWOT analysis). This strategic analysis can highlight the company's competitive advantages, potential growth areas, and strategic priorities. Investors and lenders appreciate this depth of understanding, as it indicates that the business is not only aware of its current position but also has a clear vision for future growth and profitability.

6. Enhanced Negotiation Power

Armed with a credible and detailed valuation, business owners are in a stronger position to negotiate terms with potential investors and lenders. The valuation serves as an objective reference point, reducing the likelihood of undervaluation or overvaluation disputes. This objectivity ensures that the business owner can secure fair investment terms or loan conditions, ultimately benefiting the company's long-term financial health.

7. Due Diligence Facilitation

For investors and lenders, due diligence is a critical phase of the decision-making process. A well-prepared valuation report streamlines this process by providing all necessary financial data and analyses in a coherent and structured manner. It saves stakeholders time and resources, making the investment or lending process more efficient. Moreover, it reduces the chances of last-minute surprises or discrepancies that could derail the funding process.

In conclusion, a well-conducted business valuation is instrumental in securing investment or loans by providing a credible, data-driven assessment of a company's worth. It builds trust, offers a comprehensive financial picture, assesses risks, provides accurate valuation metrics, offers strategic insights, enhances negotiation power, and facilitates due diligence. These factors collectively increase the confidence of potential investors and lenders, making them more likely to provide the necessary funding.

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Managing Director
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