Why Business Valuation Shortcuts Don’t Work
The Story Behind the Numbers . . .
I have 100% ownership of a third-generation plastics manufacturing facility. My 58th birthday is coming up and that has me really thinking about what comes next for the business after I retire…or I should say so that I can retire in the foreseeable future.
I have a number in my head that I need the value to be, but am still left wondering how much my business is actually worth. I have heard about using different multipliers for different industries. Can you tell me what multiplier or other business valuation shortcuts to use for the plastics industry?
Kudos to you for thinking about the value of your business BEFORE you are ready to actually sell. It’s never too early to plan ahead — and you’re thinking about the right things, sort of. Let me explain.
You’re smart to be thinking about how much your business is worth, and I hope you’re also thinking about other related topics like who might be the buyer of your business—family member, employee or employee group, competitor, etc.
I know it’s tempting, but while multiples of revenues or earnings are regularly used in the publicly traded stock market, they really have little meaning or use in the world of privately owned businesses. This is because one privately owned business is NOT like another, even if it’s in the same industry. Each business is unique—it has different markets, different cultures/employees, different competitive environment, different financing/debt levels, and different business plans to name just a few. None of these items are captured on an income statement. There is just SO much more to your story — and valuing closely held businesses by using a multiple is meaningless.
So, how does one determine the value of a closely held business?
Since we cannot rely on multipliers of a number on the income statement, we primarily rely on the income approach. This approach instructs us to review the historical financial information for the specific company but also to “look under the covers of the business” for the story behind those numbers. While financial performance is an important driver of value, in reality, there are numerous factors, or levers, that drive value beyond revenues and profits, including:
- A company’s brand and reputation
- Intangible assets such as patents, trademarks, etc.
- Geographic location and diversity
- Dependency on a single customer or supplier
- Quality, depth and tenure of employees
- State of technology
- Regulatory environment
- Dependence on a key employee or owner
- Consistent, clean, high quality accounting records
- Company culture
- Capital structure (mix of debt and equity)
- Internal systems in place and documented
So again, when it comes to privately owned businesses like yours, there are many unique factors that come into play even within the same industry. The documents we request at the beginning of an engagement and the conversations we have with our clients uncover so much more to the story than a multiplier of earnings or revenues could ever reflect.
We’ve seen differences of as much as 18% when we’ve done retroactive analysis on what using various multipliers would have done to a business we valued. This is why we feel so strongly that it’s not in a business owner’s best interest to use business valuation shortcuts or “rules of thumb”.
Please feel free to reach out to me if you’d like to talk further about what a business valuation entails. We have a significant amount of experience valuing businesses in the plastics industry.
PS—we get this question so often that I recorded a brief video to discourage business owners from giving into the temptation to take shortcuts that could cost them significant money in the long run!
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