Common Mistakes in Business Valuation

  • Not really defining what is for sale – Are all of the trademarks, copyrights, patents or other intangibles included in the sale price? For example, in the sale of a fast food chain, are the proverbial “secret recipes” included in the transaction price?
  • Forgetting favorable attributes – A stone quarry may have one of the few available permits to excavate in a particular state or county, or a distribution business may own exclusive territorial rights, etc. These attributes should result in a premium on the valuation of the business.
  • Not discovering the true level of earnings – Making accurate adjustments to earnings (normalization) is essential to recognizing the real earning power of a company.
  • Not finding the value detractors – Nothing is perfect. Is the revenue concentrated in just a few customers? Is the equipment antiquated? Are the financial statements in disarray? Will significant capital expenditures be required in the near future? Consideration must be given to the impact of potential value detractors such as those listed above.
  • Forgetting the real value of the assets – It is easy to forget that particular balance sheet items may be worth more than their indicated book values. For example, capital equipment may have been depreciated to an amount significantly under its actual value.
  • Selecting the incorrect earning period to capitalize or discount – Are they last year’s earnings, an average of the past few years, or merely a projection of next year’s earnings? Historical earnings cannot be used if future earnings are expected to be substantially different.
  • Choosing an inappropriate multiple or capitalization rate – Is it applied to EBIT or EBITDA and why? How was this multiple derived? Today’s EBITDA multiple is not necessarily tomorrow’s!
  • Not considering current market conditions – The current business climate and economy can significantly impact valuations. Changes in overall market conditions can cause valuations to substantially fluctuate. This point can clearly be seen in the recent devaluation of Internet companies.

Copyright 2006 Business Brokerage Press