In selling your business, price doesn’t always equal value

By Jordan Martel, From Business in Vancouver Magazine, July 12, 2018

Want the answer to big questions like whether it’s time to pass the business on to the kids or if selling the business will result in enough funds for retirement? A business valuation can be your most important tool.

As a valuator, I rely on information like historical financial statements, budgets, forecasts and the current state of the economy and industry. Once a valuation is complete, our corporate finance team will often help those same clients sell. And the price at which the business sells can sometimes be more (or, on occasion, less) than what the valuation presented. It can be a bit humbling for a valuator when it looks like you got it wrong. And, on those occasions when price doesn’t equal value, there are typically some common explanations.

First, some context.

Delivering a thoughtful valuation requires an analyst to work under a lot of uncertainty. Can the business sustain its earnings? Does it require significant capital investment in the future? Is there sufficient working capital to support growth? With these variables in mind, we’re forced to reduce some of the uncertainty and create a system that is predictable, understandable and transparent.

In Canada, the Canadian Institute of Chartered Business Valuators provides a guide to applying certain fundamental valuation theories, with the fundamental principle being fair market value. In short, fair market value estimates the cash transaction amount, assuming both buyer and seller are willing and able to transact, are free of any restrictions in an open market, have no compulsion to buy or sell, and have open knowledge of the facts. Here’s how these factors can cloud a valuation:

Willing and able buyers and sellers: Imagine an estate situation in which the children of a deceased business owner have a disagreement as to whether the business should be sold (at a price that makes only a few siblings happy). Similarly, investors, boards of directors, activist shareholders and other external forces can cause a buyer to begrudgingly buy – and perhaps overpay to get a deal done.

Acting at arm’s length in an open and unrestricted market:  Business in the real world is a contact sport. There’s overlap between business relationships, personal relationships, interconnected businesses and cross-ownerships. Despite best efforts to appoint independent directors and to maintain good corporate governance, there are situations in which negotiating parties are not acting at arm’s length – possibly resulting in a deal that does not equal fair market value.

Compulsion to buy or sell:  Business owners can feel pressure or compulsion to transact. The stress of debt is a culprit of this pressure in many instances, but there are a variety of others. The daily stress of the job affects mental health, causes problems with personal relationships and leads to burnout. Pending or threatened litigation – and just the fact that everyone gets older – can be factors in owners’ desire to exit. 

There can also be tremendous pressure to buy. Public companies, private equity funds and regional players usually have one defined mandate – to grow. The quickest path to growth is through acquisition, and in a competitive market for businesses, this can create competition (and compulsion) to buy – a great scenario for a seller of a business.

Both parties have reasonable knowledge of the facts: Mark Twainfamously said, “Get your facts first, then you can distort them as you please.” Different perspectives on accounting and business policies, including how and when to recognize revenue, equipment and intangible asset depreciation rates, to name a few, can create benefits or drawbacks, depending on your perspective. So, while we assume our hypothetical buyers and sellers in the market agree on the facts in a business context, reality tells us that beauty is in the eye of the beholder.

The complexity of the real world creates variables that often pull transaction prices away from fair market value. However, this doesn’t take away from the importance of valuations as critical planning tools that help business owners understand their options. So, if you want to know if an offer for your business is attractive, whether to buy out your partners, or how much to pay for a competitor’s business, a valuation is a good place to start. While the numbers may not always be exact, we often paint a pretty accurate picture. 

Jordan Martel is a partner at Sequeira Partners and a chartered business valuator. For more than 14 years he has been advising clients in Canada and the United States on complex valuation issues across a variety of industries.