Top Valuation Mistakes You Must Avoid.

“Valuation is vague and arbitrary, when there is no assurance that it will be generally acquiesced in by others” –  Jean-Baptiste Say

Business valuation is crucial for countless business owners that can be a deciding factor to sell, continue or even adjourn a project.  Whether or not a business owner plans to sell or transfer their business in the next few years, obtaining a proper business valuation is essential. A professional valuation performed by an accredited specialist, based on accurate modelling and sound numbers, is more likely to result in maximum financial returns for the business owner—either as an ongoing business or ultimate sale.

The following are a few mistakes one must avoid during the valuation process.

1. Having quixotic expectations

Business owners often tend to have an unrealistic view of their company’s value. One of the reasons for this could be because of unrealistic and exaggerated assumptions about future earnings or cash flow, lack of understanding of buyer appetite for their company or lack of knowledge about how company valuation is normally done.

As a result, start up Founders and Entrepreneurs can end up questioning the results of an outside valuation. At the same time, buyers too, set unrealistic expectations about a target company’s value. For instance, they may be ready to pay a premium for the business because of anticipated synergies, but buyers often underestimate the costs of an ownership transition and overestimate savings from the merger.

2. Trying to do your own valuation

Valuation is a complicated process that can involve various methods and levels of complexity and assurance. The choice of valuation approach depends on a variety of factors like the type of company and transaction, and the information available.

Mistakes often happen when entrepreneurs try to determine a company’s value without the help of a chartered business valuer. Some common errors include:

• using a valuation method unsuited to the type of business or its level of returns or cash flow stability
• Mixing valuation methods inappropriately.
• failing to normalize earnings by adjusting for special factors, such as discretionary and non-recurring items, and non-market-rate revenues and expenses
• applying an inappropriate multiplier of EBITDA (earnings before interest, taxes, depreciation and amortization)
• using the book value of assets rather than fair market value
• making unrealistic assumptions in cash flow or earnings projections
• failing to consider governance and ownership transition capacity

3. Withholding information

When hiring a business valuer, you must be ready to share in depth information about the company and work in synchronization. Some entrepreneurs may feel uneasy revealing confidential information, but providing all the necessary information is essential for a realistic and justified valuation.

As well, the process does not just stop at supplying the numbers and awaiting a valuation figure. The Valuers often need to make on-site visits, meet key personnel and ask follow-up questions to understand the business and enhance clarity.

4. Expecting valuation to stay the same

It’s common for business owners to mistakenly assume that a valuation will remain valid over time. This can cause conflict among owners. For example, an owner’s family members may become upset if the business is sold and its value subsequently rises.

In fact, a company’s value can change for many reasons, including market conditions, new regulations and sales trends.

5. Lack of proper Due Diligence and insufficient data gathering and analysis

The lack of proper due diligence and insufficient data gathering and analysis are common mistakes in the valuation process. Proper due diligence requires a thorough understanding of both the company’s industry and business. To ensure the proper level of due diligence for the business is being valued, the qualified professional interviews the owners and other key stakeholders, visit the company’s offices, and becomes versed in all relevant aspects of the business. As for data gathering, it is imperative that data utilized to formulate calculations are always readily verifiable from current and credible sources. Data that is unreliable or dated can be more easily challenged by opposing counsel in legal disputes.

6. Errors in Calculating Discount/Capitalization Rates

The discount or capitalization (cap) rate is one of the critical factors in the income approach to valuation. Numerous errors in computing discount or cap rate calculations can occur in multiple places. Exhibit 1 illustrates where errors in the components of discount and cap rate calculations often occur.

Exhibit 1 Cost of Equity

When the build-up method is used to calculate these rates, the rates must be applied to their correct and corresponding benefit streams. The capital asset pricing model (CAPM) rates reflect the expected equity return of the business. If the wrong beta is used to calculate the discount/cap rate, the numbers can be distorted.

For example, using historical industry data or an average of similar companies’ betas can be inaccurate because they do not necessarily reflect the valuation of the company’s dynamics.

7. One Size Does Not Fit All

Business valuation is both an art and a science. Not one-size-fits-all proposition, credible and reliable valuations are based on a variety of factors, including historical facts, calculations using past and current data, and subjective judgments. To be assured of accuracy, the valuation should be performed by a qualified professional who is immersed in the relevant facts and details of the company and industry.

The complex valuation process is prone to a multitude of common mistakes, errors, and omissions that can skew a final valuation number and render it inaccurate and legally inadequate. Hiring a business valuation professional requires thorough, diligent consideration to make sure an accredited, experienced, and reputable valuation partner has been chosen.

8. Valuations not performed by a qualified professional

A proper credible business valuation includes numerous complex variables that must be considered. If a valuation is not performed by a qualified professional, the likelihood of mistakes and inaccuracies increases significantly. Although many business brokers and CPAs offer business valuation services, they are not likely to have the experience, expertise, and depth of knowledge as valuation professionals. 

It is essential that the valuer hired to do the valuation is current in their knowledge and skills. The art of valuation is dynamic and continually evolving. A valuer must be aware of new precedents and guidelines regularly emanating from court cases and IRS pronouncements. There are always new types of risks that need to be incorporated into valuations. For example, there is the risk of cyber-data breaches that could be detrimental to the value of a business.

Historically, valuations for private companies have utilized traditional valuation methods. Valuers of public companies have been more innovative in the ways they view different businesses and industries, which has led to new methods that can be considered for certain private companies.

How can we help you?

Omnifin\’s Valuation service assists startups to large MNCs in their pursuit to business restructuring, fund raising, financial reporting and regulatory compliances.

Our Valuation associates and partners consist of professionals such as Registered Valuers (All asset classes), SEBI Registered Category, Merchant bankers, Chartered Accountants, Finance professionals and more.

For any queries write to us at valuation@omnifinsolutions.com or call us +91 88 2000 1234.