“Money flows in the direction of value.”

Uche Ugo, International Brand Consultant

Valuing a business is an inherently difficult undertaking, but it’s a critical step in planning the sale of your company. Valuing a business is challenging due to the following factors:

  • Limited Information: There is a limited amount of information available to accurately value small to mid-sized businesses.
    • Information on the business and its industry and comparable transactions is usually limited, biased, unverifiable, or inaccurate.
    • The value of other businesses, which is necessary information for comparable transactions, can only be determined once, when the business is sold, and information on small business transfers is scarce. There is therefore a lack of accurate information on comparable transactions. 
  • Forecasting: The value of a business can be impacted by future events and human behaviors, which are impossible to anticipate.
    • Predicting human behavior is futile.
    • Predicting future cash flow in a business is difficult, if not nearly impossible.
    • Predicting the impact of future external factors, such as changes in the economy or industry, is impossible.
  • Buyers: There is a wide universe of potential buyers with diverse criteria who will pay widely different prices.
    • Perceptions of risk, and therefore price, vary across a wide group of buyers.
    • Lost opportunity costs vary among buyers, especially for small businesses.
    • The value of synergies is difficult to estimate, and can’t be accurately predicted until the business is sold.
  • Judgment: Biases and conflicts of interest can cloud an advisor’s judgment.
    • Appraisers lack real-world experience in selling companies.
    • Appraisers’ unconscious biases cloud their judgment.
    • The structure of a broker’s compensation may affect their opinion.
  • Time and Effort: Properly valuing a business requires significant time and effort, and software tools are inadequate.
    • Properly valuing a business takes significant time, and most business owners don’t want to pay an expert to invest hundreds of hours appraising their business.
    • Most valuation software is not designed for M&A transactions.

In this chapter, I explore why valuing a business is inherently difficult, and why the ranges of potential values for a business are much wider than for other assets. After reading this chapter, you will have a greater understanding of the challenges you may face when valuing your business, and learn what factors can affect the potential range of values for your company.

The essence of valuing a business is predicting its future cash flows and then placing a price tag on those cash flows based on their present value.