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Selling a Company: The Problem of Overvaluation

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It is not unusual for private business owners to have high expectations of the price they will get for their company when it is time to sell. This often leads to unrealistic asking prices that make potential buyers reluctant to get involved.

Last week I met with a business owner after an introduction by his accountant. He was thinking of selling his profitable waste recycling business, a business he had been running for nearly 30 years. The business had a reliable management team, an enviable customer base and a strong balance sheet. Unfortunately the owner had a vastly inflated idea of the value of his business.
 
What Leads To Unrealistic Business Valuation Expectations?
 
This business owners approach was not untypical of many or the situations we come across in our daily work as a business broker. His thought process went something like this: “‘I’ve built this business over 30 years so it must be worth a lot of money. A couple of years ago we built a nice place to retire to and need to clear the mortgage. We also need a couple of million to create a pension pot that will maintain our lifestyle. The business has provided us a very nice lifestyle and will do the same for the new owners – it has to be worth about £3 million.”

It’s difficult to be objective about something you’ve built from the ground up. A business that has shaped your life and underpins your standing in the community. Funnily enough £3 million happened to be about the figure he needed to meet his retirement aspirations.
 
What Really Drives Business Valuations?
 
It comes as a shock to a lot of business owners but the value of their business is fundamentally about the cash flow it generates. In this case the business generated £250k cash flow to the owners, had £0.5m of working capital and freehold real estate worth another £0.5m. I valued the business at £1.5m to £1.8m. This was a genuine shock for the owner.

Remember when it gets down to brass tacks the value of a business is based on the income it will generate for the new owners, and the potential they see for growth. It has nothing to do with the number of years you have spent building the business – sentiment just doesn’t come into it.

Needless to say I did not get the instruction. The business is now listed with another broker at £3 million. Presumably this broker believes he can manage the client’s expectations when the business has been on the market a few months. Unfortunately some brokers do overvalue businesses because that’s what the seller wants to hear, and to improve their prospects of securing the instruction.
 
What Harm Can It Do To Set A High Price To Start With?
 
A seller might well think that trying an unrealistic price to start with does no harm – but that is far from the truth. We recently took an instruction for a business that had been on the market for 2 years with another broker at £1.5m. On a good day it was worth £750k and the owner had come to realise that. Unfortunately he had turned down two offers at that level. As soon as we began the marketing process it became clear that the previous asking price hung around the business like a bad smell. It takes a lot of effort and expense to buy a business and credible buyers were reluctant to get involved. They felt the seller still had his heart set on the higher price, and when it came to the crunch might decide not to sell – so why waste their own time and money?
 
How Do You Make A Realistic Judgement About Valuation?
 
So how as seller do you make a realistic decision about the value of your business? As a starting point remember that a broker has nothing to gain by putting forward a low valuation. Their valuation is likely to be an honest appraisal based on information provided, and knowledge of the market. My advice is to meet with two or three brokers and listen carefully to what they have to say. They will be far more objective than you could possibly manage. Ask each broker to put his valuation in writing, with an explanation of how he arrived at the suggested figure.

 

If you are interested in finding out more about these and other issues relating to the sale of a private company one of our business sale experts would be delighted to talk to you in complete confidentiality. Click CONTACT ME to book an initial phone conversation or call us on 01604 432964.

 
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