It’s tempting to want to trust a business valuation calculator. I get it. I mean, I really get it. The whole exercise of getting a business valuation seems expensive and time consuming. Why in the world does it have to be so hard?
I started doing business valuations on a regular basis in 2008. It’s now an indispensable part of our overall process for selling a business at Allan Taylor & Co. Business valuations are so important that we literally will not sell a business without doing a valuation first.
But here’s a confession: If I could trust the results from a business valuation calculator, I would tweak my process and use one all day long.
I would love nothing more than to stop combing through years of profit and loss statements, balance sheets, and tax returns. It would be swell if I didn’t have to ask business owners 52 critical questions that 15 years of business brokerage experience has taught me to ask.
If only it were as easy as plugging a few numbers into a website and getting an answer in minutes! Alas, it is not.
In this article, we’ll talk about what makes using a business valuation calculator seem like an attractive option. We’ll look at the primary limitations of using an online business valuation calculator, what to keep in mind if you do use one, and why there’s no substitute for working with a trained professional.
NOTE: This article assumes that the owner of a lower middle market business (annual sales <$20M) needs to know the market value of 100% ownership of the business. It also assumes that the purpose of the valuation is for selling the business to an outside buyer.
The Allure of the Business Valuation Calculator
It’s not hard to see why a business valuation calculator seems like a great alternative to a traditional business valuation: It’s quick, cheap, and easy.
After all, finding the value of other assets – real estate, vehicles, publicly-traded securities – is a straightforward endeavor. Why does valuing a small business seem like such an opaque chore?
Here are the main complaints business owners have about getting a business valuation:
Complaints About Traditional Business Valuations
- It’s too expensive: Expect to pay $2,500 on the low end for an uncertified business valuation. Certified valuations typically start at $5,000 and go up from there depending on the scope of the project.
- It takes too long: A business valuation usually takes about four weeks to complete, although it can easily take longer depending on the complexity of the business and the valuation analysts’ workload.
- It’s a hassle: A traditional business valuation requires gathering a minimum of three years’ worth of financial statements and tax returns. Additional reporting is usually needed, like sales by customer and product, owner’s salary and everything that goes into seller’s discretionary earnings (SDE).
- It feels intrusive: Business owners often ask us to sign a Non-Disclosure Agreement (NDA) before starting our business valuation process. This is completely understandable, as you’re sending a lot of sensitive information to a complete stranger.
On the other hand, using an online business valuation calculator has the following advantages:
Advantages of Business Valuation Calculators
- It’s inexpensive: A price tag around $500 is the norm.
- You decide how long it takes: Getting a valuation from an online calculator takes as long as you want it to. You’re inputting the information yourself, so you can go at your own pace.
- It’s convenient and private: It’s just you and your computer. You don’t have to work with another human, although some online calculator vendors offer additional assistance for a fee.
- Instant gratification: All you have to do is pay with a credit card, fill in the boxes, hit “submit” and voila – you’ve got your number.
Using an online calculator to value your business is certainly enticing. But valuing a closely-held small business is like nailing Jell-O to the wall. Unlike the other assets mentioned above, the value of a business has a number of moving parts, hidden backstory that needs to be uncovered, and is constantly changing.
So, if the best way to understand what your business is worth is by getting a traditional business valuation, what purpose does a business valuation calculator serve?
The Primary Target for Online Business Calculators
Business valuation calculators are geared towards two broad user groups: Business owners and advisors. We’ve already covered the reasons why a business owner might want to use an online valuation calculator instead of a traditional valuation process.
Business valuation calculators also target the advisor community, specifically:
- Insurance agents
- Financial planners
For these advisors – most of whom lack formal business valuation training – a valuation tool can be an excellent way to generate leads and upsell services to business owners. This isn’t necessarily a bad thing. An accurate business valuation can be extremely useful when you’re helping a business owner buy life insurance, get a loan, raise capital, or plan for retirement. In fact, an accurate business value is critical for successfully doing these things.
The key word, of course, is “accurate.”
So, how accurate is an online business valuation calculator? I decided to find out.
I Put the Leading Business Valuation Calculator to the Test: Here’s What Happened
When you look at the list of advisors mentioned above, you rarely find business brokers, merger and acquisition (M&A) advisors, or investment bankers. I’m guessing this is because we are tough customers: We’re valuation experts who can’t afford to be wrong.
No valuation is perfect, of course, but it has to be in the ballpark of what’s reasonable. If not, business brokers will either a) lose a potential client, or b) set the wrong expectation with a business owner, which leads to failure and disappointment. In other words, our livelihoods depend on it.
Not too long ago, a financial planner friend of mine received a sales call from the leading business valuation calculator provider, and asked me what I thought of their solution. I said I needed to know more about the methodology and asked if I could join the call.
The presentation was impressive, so I asked if I could demo the calculator myself to determine the accuracy of the results. The sales rep agreed, although I had to submit target company information using a form (i.e. I was not allowed to input the data into the calculator myself).
To be clear, I was seriously considering incorporating the calculator into my process. As I said, I’m always trying to streamline the valuation process for both my firm and the business owners we work with.
I used data from two businesses we had valued and then sold in the past year. There was nothing hypothetical about these numbers: They were as real-world as it gets.
The calculator’s result for the first business was close enough. It wasn’t 100% accurate, but it was close enough as to not be misleading.
The result for the second business was off. And I mean way off.
When I told the sales rep about my results he grilled me on the information I sent him for the second business. I told him all the numbers were correct. He then asked if my valuations were certified. This seemed like an odd question, and was beside the point entirely.
The sales rep then admitted there was a chance he had input the information incorrectly, but by this point I had lost confidence in the process. I came away feeling like using a business valuation calculator was a coin toss: You may get a good number, or you may not.
And a coin toss just doesn’t cut it when you’re trying to make a decision about the largest and most consequential transaction of your life.
The 3 Biggest Problems With Business Valuation Calculators
Here’s the thing: I have 15 years of experience in business valuation and lower middle market transactions. Regardless, I ran into some issues with the accuracy of the calculator’s results. If a seasoned professional can’t get a reliable result, that doesn’t bode well for the average small business owner, or advisors with no valuation training.
With that said, here are the main problems I see with using on online valuation calculator:
1. The Result May Be Off
In fairness, you can ask 10 different valuation professionals to value one business and you’ll get 10 different answers. Although the majority of the answers will cluster around a range of values that are all fairly close.
As my experiment shows, there is a lot of room for error when it comes to determining business worth. Even using common business valuation formulas like EBITDA (earnings before interest, taxes, depreciation and amortization) times a multiplier, a lot goes into adjusting cash flow and getting an accurate valuation result.
The report that I received from the calculator software actually gave four business values: Asset, Liquidation, Equity and Enterprise. I only care about market value (Enterprise), so perhaps the other values would have been fine for the purposes of a bank or insurance company, or offering investment guidance. All I know is that – from a business broker’s perspective – I wasn’t convinced that a calculator would give consistently reliable results.
TIP: If you do use a business valuation calculator – either on your own or with an advisor who is not trained in valuation – take the results with a grain of salt. They may or may not be accurate, or appropriate for the purpose.
2. It Doesn’t Address “Sellability” Issues
When we talk about valuation at Allan Taylor & Company, we have a simultaneous discussion with owners about what we call “sellability.” You can come up with a value range for your business – say between $4.5 and $5M – but that leads to another question: Would a buyer actually pay you your asking price?
Furthermore, even if a buyer agrees with your business valuation methods, how and when would you get paid? And what would your net proceeds from a sale – after paying fees, taxes and liabilities – look like? It’s not what you get, after all, it’s what you keep.
Some sellability issues are tangible, while some are not. They can impact not only value, but the potential buyer pool for your business and possible deal structure.
Some examples of sellability issues include:
- Differing expectations amongst owners/partners
- Entity structure (ex: C corporation with shares inside a retirement plan)
- Role of customer concentration (i.e. buyers may or may not care)
- Reliance of business on one or a handful of people
- Role of supplier concentration
- Competitive advantage (or lack thereof)
- Accuracy and reliability of financial statements
- Responsiveness and demeanor of seller
TIP: Business valuation is about more than a number. If you use a business valuation calculator, be aware that there are intangible factors that the software can’t fully address.
3. Where Is the Art?
It’s often said that business valuation is both art and science. The art part comes from experience and good ol’ gut feel, something an online calculator can’t replicate.
Business brokers learn a lot just by having a dialogue with a business owner. One question can lead to another, which takes you in a different direction that uncovers a new wrinkle. While I want to get a look at the financial statements of a business as soon as possible, experience has taught me that you never know where the discussion might lead, or how it may impact the bigger picture.
TIP: If you want to know the market value of your business, it’s best to speak with a business broker or M&A professional about what your business is worth. It takes a lot of experience to understand what may or may not occur in a real-world sale scenario.
Get a Professional Business Valuation When It Really Matters
The notion of a quick and easy business valuation solution is attractive, but it’s no substitute for working with an experienced valuation specialist. If it’s critical that you get a reliable result – like when you’re contemplating a sale – you’re better served by working with a business valuation professional.
I’ll admit that my opinion on this topic is extremely biased. Although I’d like a quick and easy valuation option as much as the next person.
The truth is that business brokers spend an inordinate amount of time educating (or re-educating) business owners about what their business is worth to buyers, and why. If expectations for a sale are set incorrectly, the results can be costly. The valuation gap is also the number one reason deals fail to close. For all these reasons it’s hard for me to support something that runs the risk of exacerbating what are already-pervasive problems.
Most business owners have 80% of their net worth trapped in their biggest asset, their business. Ask yourself one question before using a business valuation calculator: Can you afford to be wrong about what your business is worth?
The advisors at Allan Taylor & Co. have been helping business owners understand the value of their business since 2008. Reach out today if you’re ready to start the conversation.