Bridging the Valuation Expectation Gap

According to Spardata, a Maryland-based valuation firm, the typical business owner (regardless of industry) misjudges the value of his or her company by 59 percent.

And it’s certainly something that we see every day, as well. Unfortunately, many wealth management business owners falsely believe that the valuation of their firm is much higher than it is in reality.

Some of this may be because of certain valuation myths that are perpetuated in the industry – such as that of businesses trading at a multiple of revenue (hint: they don’t).

In other instances, owners have a certain dollar amount in mind that they’re counting on in order to retire (surprisingly, many owners in this space hold a concentrated stock position in their own company), regardless of what their business is actually worth.

And let’s not discount or dismiss the certain amount of ego that is tied to being a business owner (because the thought is that no one else can replace you and what you bring to the table).

It can be a tough pill to swallow when a formal valuation yields a lower valuation than what you assumed. Or when a potential buyer offers a lower purchase price than you’d expected or hoped for.

Much of this leads to owners not transitioning their business in a timely manner – often because they’re not going to realize what they think their business should be worth. Unfortunately, that only exacerbates the problem because the value of the business will typically continue to decline as the owner/advisor (and their client base) ages.

The real challenge becomes that of educating owners on the realities of valuation. It’s a delicate topic at best and one that frequently causes frustration and distress for the owner who is contemplating a sale.

Truelytics takes the approach of viewing and valuing a business through the eyes of a potential buyer. Like your investment clients, buyers aren’t necessarily too concerned with current or past revenue or even historical cash flow. Instead, like any smart investor, they’re primarily driven by how a business will perform going forward – and look at the future benefit stream, and how risky or stable it may be.

Once a business owner understands what drives value and the methodology behind the proper approach, the next step is to determine whether the valuation gap can be addressed in the deal structure.

Using an earn out as a component of the deal structure allows a selling owner to participate in any “upside” that the buyer realizes. This requires the seller to keep some skin in the game and have confidence that the buyer will realize some synergies on the P&L or achieve a higher revenue number – it’s certainly not for everyone and does involve a certain amount of risk.

Of course, it’s always best to have a solid understanding of how your business will be viewed and valued well in advance of any contemplated transition. The good news is that when you use a valuation tool like Truelytics to understand the health of your business and identify areas that you can improve, you gain the advantage of avoiding any surprises, as well as the opportunity to increase your valuation over time.

Want to learn more? Schedule some time to speak with one of our professionals.