The art or “science” of business valuation

Whether business valuation is an art or a science is a long debate. Finance professionals have produced numerous theories for business valuations. professional evaluators however insist that no valuation should be based only on a single method. Evaluators generally perform a series of calculations using multiple methods and then choose a valuation range using their own judgment.

Assessing the value of a business is often a combination of financial calculations and personal judgment based on the evaluator experience of similar transactions and a variety of adjustments to reflect differences in business models, environment, regulations, markets etc.

A small business is only worth what somebody is willing to pay for it. That introduces the notion of the value to the buyer as opposed to the intrinsic value of the business. Potential buyers who can see some synergies with the business will probably pay more for the business. Examples of synergies include cost reduction due to increased economies of scale, access to distribution channels enabling cross selling, access to new technologies, access to valuable brands etc.

Unfortunately the assessment of the synergistic value has always been extremely uncertain. Various acquisitions turned into financial disasters simply because most of the expected synergies never materialized. Research have shown that in large corporations, most of the enthusiasm for large acquisitions is mostly driven by executives seeking more power.   The larger the corporation, the larger the power of executives and their pay.

In the small business arena, most valuations are based on the companies history of profits not on the possible synergies. This is mostly because small business buyers are conscious of the high uncertainty in the small business environment. Why would somebody pay for the potential the the business might have. Small business buyers buy a business because of its potential but they only pay for its past results.

However, this doesn’t mean that a business with a bright history but a bleak future will still sell based on its history. The future is still the principal element buyers use in their decision to purchase a company.

Valuing a business before deciding to sell it is certainly a good decision. However, a business seller should understand the various limitations of business valuation and should remain flexible to the market reaction to his listing.

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