When you are preparing a valuation for your business with a VR business intermediary, do not attempt to embellish and create false numbers. This will only hurt your chances of selling your business to the right buyer. You want to be honest with your VR business intermediary. This means you need to avoid mistakes that over small business owners have made when trying to estimate their value.
Projecting Unrealistic Cash Flow
The most common mistake with performing a business valuation is unrealistic cash flow projections vs. the discount rate being used in the discounted future cash flow analysis. Aggressive growth projections carry high risk factors and prompt an increase in the discount rate used – required rate of returned. This is the scenario when the projections are not supported by good market research and the analysis of the business.
Using an Earnings Multiple
Using a fixed discount or capitalization rate with many different earning streams is another common mistake that you want to avoid at all costs when valuating a business. The discount or capitalization rate will increase as the earnings ladder does – net income up to pre-tax income up to EBIT up to EBITDA, etc.
Emphasis with Using EBITDA
You want to use caution when you use EBITDA because of the requirements for above average projected working capital or capital expenditures. Remember that a discount free cash flow analysis should always be completed as everything revolves around available capital. A short-term projection will always be one that eliminates taxes, depreciation and amortization. When you sell a business to an owner, taxes will have to be paid on that business down the line; therefore, it will have to replace depreciated tangible and amortized intangible property.
Apply the Comparable Company Method
Remember that no two businesses are alike in both financial and operational structure. Therefore, be warned when you perform the comparable company method unless thorough and correct research is done to assure that the businesses being used as a comparison are in fact similar in structure to the actual business that’s being valued.
Applying Adjustments to Earning Streams
You want to avoid overusing add-backs or adjustments to the earning streams such as non-recurring income or expense and officer salary adjustment. Many sellers will add back actual business expenses and leave non-recurring income, when it should be the other way around. Additionally, they will adjust officer salary to below industry averages. Ask yourself if you would take a $50,000 annual salary to run a $10 million business?