What are some common mistakes to avoid when valuing a business?

Discover the top mistakes to avoid when valuing a business - and don't let these common errors cost you money

Many things will contribute to the value of your business. Whether you're looking to sell it immediately or not, you may want to get a feel for where you stand. Sometimes, the valuation results you are looking at simply aren’t adding up. Maybe you own a casino for Bitcoin, and you know its performance and the figures you see do not align. 

Business valuation is undoubtedly important. Unfortunately, you lose a number of its advantages when mistakes are made. Here is a look at some of the common ones you want to steer clear of. 

Fixed value expectation 

Going into the valuation process with the correct mindset is essential. This means you need to understand that you're not dealing with an exact science. It is unlikely that you will receive a single precise value for the business that will be accepted by everyone on the market. 

What you will likely get is a price range that you would probably offer to an arms-length party. This concept speaks to a buyer without reason to pay a lower or higher cost than fair market value. To understand better, consider that loved ones, such as family members, may be able to get a better price because of your relationship. 

Note that businesses in the technology sector and smaller companies will likely see broader ranges. Additionally, please understand that the standalone value is what is reflected. In other words, strategic partnerships or potential synergies don’t matter. Therefore, the final transaction price and the valuation result are often different. Some of the elements that may affect the cost are: 

  • Due diligence 
  • Available financing 
  • Expected strategic interests 
  • Transitional potential 

Once you have this understanding, you begin to realise that a fixed value is unlikely. Therefore, you can properly manage your expectations. 

DIY valuation 

Valuation is not a simple process. Different methods, alongside other elements, can make a mess of things. Additionally, depending on the available information and the type of company, a certain approach may be needed. 

It stands to reason then that entrepreneurs will often make mistakes when they don't seek professional assistance. Trying to go the DIY route will often introduce these common errors: 

  • The choice to mix valuation methods inappropriately. 
  • Accidentally ignoring the business's sales trends. 
  • Choosing a method that does not match the company's cash flow or level of returns. 
  • Ignoring the fair market value of assets by using the book value. 
  • Not normalising earnings by adjusting for special factors. 
  • Failing to think about ownership transition capacity and governance. 

Unless you have the qualifications and experience necessary to carry out your own valuation, it is in your best interest to bring in the experts. 

Flawed model use 

All models cannot be used for every business. Typically, valuators will use either the asset approach, market approach, or income approach. Each one of these has different methods that fall under it, and the one your business needs depends on the nature of the engagement. 

A professional will consider your economic situation, after which one will be chosen. Regardless of what the selection is, it needs to address the following: 

  1. Risk level and treatment 
  2. Off-balance sheet liabilities 
  3. Non-operating assets 
  4. Non-financial consequences of potential sales 

If these are properly considered, then the conclusion of the process will be reasonable. However, if the wrong model is chosen, then the result will be questionable at best. 

Inappropriate capital structure assumptions 

Your company's capital structure is its combination of equity and debt. For obvious reasons, this will heavily affect your cash flow, which makes it very important to the valuation. Experts will try to pick the best capital structure while evaluating controlling interests. This will lead to a ratio being selected for calculations to be done. 

Doing this makes sense, as a new owner can change the ratio when the controlling interests become different. The opposite is supposed to apply to minority interests. Unfortunately, this is where a common mistake happens. Remember that non-controlling shareholders cannot affect the capital structure. Therefore, the existing ratio should apply. 

Ignoring company-specific risk 

Risk assessment is essential to any valuation. When you start to use irrelevant discount rates or capitalisation, you will likely get misleading results. Every company has operational and financial elements that come together to create its risk profile. Therefore, yours should be unique. 

The moment you start to apply any kind of one-size-fits-all rate is the point at which errors can be easily introduced. 

Lack of ongoing valuation 

If you think that there's no reason to do a valuation unless you're ready to sell, you're making a mistake. Going through the process can prepare owners for triggering events that they would otherwise be unaware of. 

Additionally, if your business is highly valued, there are some estate tax concerns to think about. This may mean that you need to go through a sophisticated planning process. 

Who knows? Having a valuation done could be a big part of securing a business loan, bringing in key employees, and more. 

Remember that you are allowing yourself to learn where you stand. Ideally, you are not looking to stay stagnant. Knowing your starting point allows you to begin to strategise your value enhancement efforts. 

Making the right adjustments can increase your profitability. Therefore, when you are ready to sell, the price can be higher. 

Failure to distinguish project costs from the purchase price 

The purchase price and project costs are not the same. Simply thinking along that line is a huge mistake. If you are valuing a business for a purchase or sale, make these adjustments:

  1. Deduct the costs of deferred equipment maintenance from the purchase price. 
  2. Consider the working capital the buyer needs to inject. This amount will be above the purchase price in an asset sale. 
  3. Adjust your business value by an appropriate amount, as investments may be needed to maintain income. Maybe it's the cost of licenses, hiring staff replacements, becoming compliant, etc. 

Remember to avoid these mistakes! 

As you can see, several common mistakes may be made when valuing a business. Use the information you've been given to avoid them. Even with your new understanding, it's in your best interest to leave the process to a professional.