Lately, a real estate friend asked me to help one his customer set a price value on his business. Now at 73 years old, his customer wanted to sell quickly to start enjoying his retirement.
So I took the time to contact him. We had a talk on past and future financial performance of his business, its structure, the health of its industry, his customers, etc. At the end of our phone call, I felt I had enough information to give him a ball park idea of a price value range:
Me: Sir, based on the information that you’ve provided me with, I would say that $200,000 would be a fair value for your business.
Sir : Is that a joke? It's worth at least $500,000 and I need the money if I want to enjoy my retirement!
Me : Sir you might be right, this company could potentially be worth $500,000. But what do you base yourself on to valuate to such a high amount?
Sir : There is this new service which is very promising for the company, but in which I have not invested much time, mostly because I don't have the energy I had few years younger! I am sure that this provides added value to the business.
Me : OK, so, correct me if I’m wrong, but you are asking a potential buyer to pay for a promising idea? An idea that he will have to develop alone, investing his own time and money to confirm its potential? Sir, would you be willing to pay $300,000 for this idea? Do you have a serious market research that demonstrates without any doubts the true potential? Stats that could convince potential buyers of its true value as of today? How much money do you think that the buyer will need to inject in addition to these $300,000 in order to get to market this new service and reach its full potential? If a competitor would start from scratch to offer the same service, how much would he have to invest to achieve similar results?
All companies on the public stock markets are aware of their value on a daily basis and know instantly the impact of their decisions on it. In contrast, the majority of small business owners are into the unknown when it comes to their own business value. In general, a private company is rarely valued throughout her life. Entrepreneurs mostly ask for a value when they are looking to sell it, have shareholder issues, want to open shareholding to new investors or employees, or for tax planning purposes.
However, the main goal of any privately owned company is common: maximize the shareholders’ equity. So why, as a shareholder of a SME, wouldn't you want to know the fair market value of your investments in private companies? Yes, it's an investment, just like the stock markets or real estates!
When asked to provide a fair opinion on a company’s value, I always make sure to manage expectations by mentioning that I'll most likely be crushing their dreams! Call me "Enter Sandman!” The majority of entrepreneurs perceive the value of their business well above its fair market value. Just listen to one episode of Dragon's Den or Shark Tank will be enough to convince you. The main problem lies in the fact that most entrepreneurs never really learned about value creation throughout their life. No one never really told them what created value in their business, and especially, what made the company lose value in the eyes of potential buyers. Which in a sense seems normal: they have a business providing them with a good lifestyle, without having any boss! What could you ask more? Until the day they lose interest or they get sick or lose key employees…
As the Michael E. Gerber says in his «must read» book, "The E - Myth,” an entrepreneur starts a business by leveraging its great technical knowledge. But what completely new to them is that they become at the same time Managers and Presidents! The technician manages the daily operations, while the manager must manage the past and the president, the future! Now how is it possible to be able to manage the future of a business without any training on value creation? How can they know if their decisions and policies will have a positive or negative impact on the valuation?
Unfortunately, for those requesting a business valuation a few months from retirement, it often has the effect of a bomb. Sometimes, the valuation even brings owners to rethink retirement plans!
That said, it happens that these business owners sell for a value greater than its fair market value! This happens in presence of one of these three factors:
-A good broker
-A competitive advantage recognized in the industry
-Luck
My advice to all entrepreneurs: learn as fast as possible about mechanisms that create value added to your business.
Become aware of what can be done to create added value and also what has to stop leaking. Train yourself: read books on the subject or listen to their audio version on the go. Never be afraid to challenge strategic decisions with mentors or professionals.
Here's a few personal book suggestions on that topic:
- «The E-Myth Revisited - Why Most small businesses don't work and what to do about it» by Michael E Gerber
- «Scaling Up: How a few companies make it and why the rest don't by» Verne Harnish
- «Built to Sell: Crating a business that can thrive without you by» John Warrillow
- «The Goal» - By Eliyahu Goldratt
- «Traction: Get grip on your business» by Gino Wickam
Keep that in mind: the more you know with precision the value of your business and the mechanisms that influence it, the better your chances of getting the price you want for your retirement day!
Of course, until the day the blockchain solves a part of this issue!
The Digital CFO