Are Generic Valuation from A Business Broker Reliable?
Often in Singapore and Malaysia, a business broker or agent are likely to offer a business valuation for free or at a low cost if you engage their business brokerage service.
More often that not, they are unlikely to possess the expert skills and knowledge to perform the work; and since it would take them a significant amount of time and labour to pour through books and analyse other variables, you can presume the output quality will not be accurate.
Still, the accuracy of a business valuation does not increase with the number of hours and amount of effort spent.
Some business brokers have also started offering ‘valuation tools’ on their websites - again, these will thwart the success of a business transaction with an inaccurate business valuation and leave the business owner and the business vulnerable to inaccurate valuations.
Business brokers tend to use ‘valuation tools’ created by an unknown third party (i.e. Biz Equity or John Warrilow’s “Value Builder” system) so any inputs, such as confidential information about the business, would be sent to an outsider server and used for other purposes that may or may not be legal.
Such risks are definitely not worth it.
There may be benefits in getting a free valuation from business brokers but it is worthy to bear in mind that most of these results would be a castle in the sky.
The Following Highlights A Few Reasons Why Generic Business Valuations Would Be Detrimental To A Mergers & Acquisitions Transaction:-
Extravagant Price-to-Earnings (P/E) Ratios
Valuation multiples of established businesses and large firms are not applicable in all businesses.
Business owners in Singapore and Malaysia tend to learn from ‘only the best’ but such a practice requires an extra step of customising to individual needs, which the business brokers overlook - they would often quote examples and hearsays from friends to justify their generic valuations that are usually not practical for real use.
Why can’t multiples of ‘the best’ be used as they are?
Established companies or businesses have some sort of a ‘moat’ that protects their stability in the market. For MacDonald’s, it is their brand; for the internet backbone providers, it is the huge capital required for a network of cross-ocean fibre optic cables, which acts as ‘barrier to entry’; for some online businesses, from eBay to Facebook, it is their huge market share, and the list goes on.
A ‘moat’ gives the business its competitive advantages: (i) oversized profits; (ii) low risk profile.
Risk profile has a huge impact on the overall business valuation and it is derived mainly from the seller’s perception. Hence if the buyer saw a greater risk of growth, development and expansion in a particular business, he/she would only be willing to pay a lower multiple.
So which multiple should a business rightly adopt?
The ones from businesses that are slightly larger than the target business.
However, it is worthy to note that if there was a competitor that matched the target business in every way except they boast a double turnover and profit, they would hold a larger multiple than the target business.
Also, as size matters a lot in mergers and acquisitions, the competitor’s size also adds to their attractiveness. Hence many investors would consider acquiring the competitor as opposed to the target business, which wouldn’t make an appreciable difference in their accounts.
Buyers do not consider valuations from the seller’s business agents
Investors always know best - they prefer a business valuation done by an expert they hired; not one engaged by the business owner.
It is worthy to note that buyers would gather information useful for their decision-making via their own means and people.
They also do not spend time on deals with unrealistic sellers. Hence they would walk away from exaggerated selling prices based on the seller’s business valuation.
Since most business valuations from over-enthusiastic - or unethical - business agents are inflated, they would likely make the transaction a failure from the start.
The business may not be profiting as much as the owner thinks
As there is a tax advantage to taking a smaller salary and larger dividends, some small business owners in Singapore and Malaysia would underpay themselves.
Hence this would affect the overall view of the profits ‘earned’.
For example, if a business owner had worked 60 hours a week, received a salary of $10 000 a year and declared a profit of $25 000, the buyer would calculate the worth of the 60 hours of labour and the amount needed to hire a person with the owner’s talent.
Instead, should all of that be measure at a realistic rate of $12 per hour, which include all the necessary manpower requirements, then it would cost $720 per week and then $40 000 per year, which becomes a loss based on the declared profit.
It is pointless to even suggest that the buyer could do the job and save the hiring costs because not everyone is willing to work like the business owner.
Hence it is still worthy to make an honest assessment of the business owner’s time and effort and a justifiable salary, then deduct it from the business’s revenue to see the ‘real’ profit ‘earned’.
Valuation is not a single figure
There is hardly a case where business owners would receive cash for a sale transaction.
Offers for a business sale is usually part cash and part future payments. Sometimes other forms of payment are included as well. It is all about give and take.
Hence it is good to make a concession of the amount of cash to be paid upfront so that a higher price could be extracted in exchange for that concession.
It is worthy to note that selling only business assets instead of shares can add as much as 100% to the selling price.
Whilst the gesture to provide a very vague figure based on their experience (of going through many business buy/sell transactions) is good, one should not attribute the outcome as valid.
It is usually a means to get you on board with them exclusively.
Speak with an expert business valuer today.