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Real Estate and Business

How to Value a Business the Realistic Way

When it comes to buying, selling or investing in a business the important question becomes ‘How much is the business worth?’

As an investment banker and investor I have looked at over a thousand businesses over the last 20 years.  Those businesses were sometimes represented by a realtor, sometimes represented by a lawyer, sometimes represented by an accountant, sometimes represented by a business broker and sometimes represented by the business owner. Each one of them has their own way of valuating the business.

The business owners know the business best but are often emotionally attached which skews their valuation. Realtors often lack the business training to understand the profitability and focus on the marketing of loosely defined ‘potential’ of the business. Lawyers are masters at identifying and mitigating risk. Accountants are excellent at being able to measure profitability. Business brokers perhaps have the best reference point at any given time to put the business into perspective with what’s happening with the industry and economy.

It is no wonder that the business owner valuates the business based on what he thinks it is worth, therealtor based on what he thinks he can persuade the buyer it is worth, the lawyer based often based on the value of the assets and the accountant more likely based on the cash flow it can generate.

The above approaches are based on different valuation models:

1. Goodwill. This has nothing to do with the value of the hard assets or liabilities, rather it is based on owner’s perception of what the name of the company is worth in the marketplace in terms of attracting sales.  It is viewed as being the hard work that the owner has put into the business over the years in order to establish it as a profitable ongoing concern.

2. Book Value.  This approach looks at the value of the assets if they were to be sold right now, less the total amount of debts.  Often the owner will ask for a goodwill amount on top of this but if the business is being liquidated then the goodwill doesn’t exist or won’t be realized.

3. Cash Flow. This technique takes the average annual cash flow or EBITDA defined as earnings before interest, taxes, depreciation, and amortization over the last 3-5 years and applies a multiple. The multiple can be anywhere from 1X EBITDA (for professional practices and consulting firms) to 20XEBITDA for cable and telecommunication companies. The multiple also changes as the economy, competition and other factors change.

There are other methods that valuators will use. Basically, they’re different ways to put a dollar value on the business and really have nothing to do with what the business is worth.  Unless you are planning to liquidate the business and sell off its assets, the value of the business is what someone is willing to pay for it.

Brokers, realtors, accountants, and lawyers are advisors hired by the owner to help him sell his business. Their job is to find an ideal buyer and persuade that buyer to pay the most possible for the business. The fact that they use formulas and other techniques to put a price on that business is really irrelevant, except for their attempt to build credibility that the business is worth what they say it is.

Here is my valuation for the business – a business is worth what someone is willing to pay for it!

If you don’t believe me, ask yourself what AIG was selling for at the end of the liquidity and credit crunch of 2007-2008. In January of 2007 AIG shares were trading at over $1200 each and at the beginning of Feb 2009 AIG shares were trading at $6  per share. Even after the company had been identified as being in a liquidity crunch analysts were still claiming the value of the stock was over $100 a share. The shares may have been worth that amount, but because the buyers weren’t willing to pay anything more than $6 per share for the company, it wasn’t worth more than that at that time.

Valuating a business is only one aspect of selling the business. The other aspect is the structuring of the deal. Sometimes a lower valuation can end up providing more money to the owner that is selling the business if it is structured in a way that the owner can leverage the upside. There is always more than one way to get what you want.

If you’re selling your business or buying a business and would like some help you can find me onLinkedIn (Baldo1) or on Facebook.

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