Hey Reader,

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When I worked in IB and search funds, I valued lots of businesses. When I was in real estate, I spent time valuing properties. What I learned is that everyone believes their baby (ie business or property) is the unicorn with no blemishes.

In my experience, the unicorn believers have the worst experience. And it hurts me, especially because I know how life-changing a transition is.

Here's why these matters for a business valuation.

There are a few ways to value a business, but that's not the real point.

Remove the hidden problems first. Get that baby ready for the pageant!

Here's the top few ways to value a business. The pitfalls below are more important!!!!

Business Valuation Methods

1. Income Based Approaches (Intrinsic Methods)
   1. Discounted Cash Flow (DCF) Analysis: Forecasts future cash flows and discounts them to present value.
   2. Capitalization of Earnings: Divides expected annual earnings by a capitalization rate.
   3. Income Multiplier Method: Uses a multiple of earnings or cash flows.
2. Market Based Approaches (Relative methods)
   1. Comparable Company Analysis: Utilizes financial metrics of similar companies.
   2. Precedent Transactions: Analyzes past sales of similar companies.
   3. Asset-based approach: Calculates the fair market value of individual assets.

Common pitfalls are where you want to spend most of your time. Most of these actions involve optimizing revenue and operations. The rest are something you should consult with a specialist on for a transaction. If you're just looking to brag to your buddies, then disregard this since you were going to anyways. Ha!

Common pitfalls to avoid

1. Using inappropriate valuation methods. You don't value banks the same way as auto shops.
2. Ignoring macro factors: That is the economic, environment, competition, management, and organizational culture.
3. Using bad or old data: A quality of earnings can completely change your outlook.
4. Underestimating risk: Higher risks lead to a percentage discount. No one wants a 10+% lower value for riskiness
5. Lack of objectives: Clear goals aligned with the company's strategy are powerful.
6. Neglecting future performance: Valuation is forward-looking, so consider future earnings potential.
7. Overlooking normalizing adjustments: It's better to fix this before a buyer does. We could be talking lots of dollars!
8. Failing to consult professionals: Get help from valuation experts, accountants, and legal advisors. One of my dream cars is the Lotus Emira (Check out that beast) and you can bet all your money that I'll have a professional help me take care of it!
9. Ignoring discounts for lack of liquidity: Privately-held companies are less liquid than public ones. It matters,
10. Having unrealistic expectations: No one goes from 1M in revenue to 500M in one year, that just advertises your crazy.

Watch the pitfalls more than you do the valuation methods.

The number one example I want to point out is this.

There are two identical companies. The second company's gross and operating margin are better because it operates more efficiently. That results in a huge bump in valuation. Here's the chart to explain this example.

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That's a wrap, but if there's anything you want to see or hear more about then just hit reply and let me know!

Thanks,

Clayton

​DealSource HQ​

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