When an owner decides to sell their business, they must determine a reasonable price and a realistic timeframe.

An owner’s belief about their company’s worth often differs from its actual market value. This is usually because owners have an emotional perspective, while market valuation is based on objective financial data and market conditions. The disconnect often arises during a sale, when an owner’s personal attachment conflicts with what buyers are willing to pay for a company’s future potential.

Subjective view

An owner’s perceived value is subjective and influenced by non-financial factors, leading to a biased, higher value. A business owner has invested years of hard work, time, and personal sacrifice to build the company; however, this sweat equity has no bearing on market value. Many owners are overly optimistic about their company’s future earnings and growth potential and place a higher value on the company that may not be based on realistic projections or an understanding of the current market. Poor record-keeping, such as mixing personal and business expenses, can also cloud the company’s true profitability and lead to an inaccurate financial picture. Finally, some business success is tied directly to the owner’s personal traits, relationships, and expertise which will not count towards the company value—it is not transferable to a new owner. A business that is dependent on the owner for its success has limited to no market value.

A business market valuation is based on objective, standardized methods and relies on a buyer’s perspective of future risk and return. Buyers generally rely on the advice of professional valuators, such as Chartered Business Valuators (CBV), to determine the value of a business.

Evaluation of a company

Determining the company’s value is achieved by reviewing forecasted earnings or cash flow and past results. A company is evaluated based on its ability to generate future earnings and cash flow. Methods like discounted cash flow (DCF) and earnings multiples (e.g., EBITDA) are used to project future performance for established businesses that are generating reasonable returns and whose value is greater than that of their assets alone. Market-based methods calculate a valuation by applying a valuation multiple, which may be based on EBITDA (earnings before interest, taxes, depreciation and amortization), revenue or other metrics. The specific figure used, and type of ratio vary, depending on many factors, such as industry and size of the company, market conditions and multiples used to buy or sell comparable businesses. The most suitable combination depends on the purpose of the valuation and the company’s characteristics, such as its profitability, outlook, and asset mix.

Agreeing on a price

Attempting to sell a company at an inflated, owner-driven price can lead to significant problems such as a lack of market interest, loss of credibility in the business value and low-priced offers. Unrealistic price expectations are a primary reason for failed sales negotiations and deals fall apart because the owner and buyer cannot agree on a final, fair price.

The other consideration that impacts business value is how the sale is to happen, either as an asset purchase or a share sale. An asset purchase allows the buyer to select what they want and leave unwanted liabilities behind, while a share purchase involves buying the entire company’s stock, which transfers all assets, liabilities, and obligations to the buyer. Buyers typically prefer asset purchases for control over liabilities and potential tax benefits, whereas sellers often prefer share purchases for their tax efficiency and simplicity.

In the end it is critical for the buyer to conduct extensive due diligence to identify any “skeletons in the closet” regarding the company’s past. The aftermarket is a unique environment with few new entrants, so the ultimate value is what an arms-length person is willing to pay, with little “blue sky”, and is always based on the earning ability of the company.