Be wary of valuation calculators on the websites of many companies that refer to themselves as business valuation and M&A advisory firms. These calculators allow business owners to enter basic financial data and quickly retrieve a “value” for their business. Many of these websites describe the final result as a business valuation. Although a free, quick, and easy valuation may sound appealing, relying on the result could be a mistake. Remember, you get what you pay for.
Each Company's Valuation Is Unique
Even though certain valuation metrics are common to most businesses, the differences among companies far outnumber the similarities. Because online valuation calculators apply a one-size-fits-all approach, they can’t begin to account for these variables in order to distinguish your company from hundreds of others.
Most of these automated valuation programs collect data by asking you, the business owner, to enter it manually into the website. (This information often includes contact information, which is then used for marketing purposes.) Typically, you’ll be asked to enter unadjusted financial information for a period of several years into data fields that feed into a software program. Sometimes you might answer a series of questions intended to provide a more specific context for the valuation, such as questions about the industry and geography in which your business operates.
The software program then categorizes and “analyzes” the financial data you’ve provided, applying certain pricing multiples from “similar” companies. The results from this “analysis” typically yield a range of values for your company. This is appealing because you can get results relatively quickly, usually for free, and maybe anonymously. However, this process is rife with pitfalls that could inaccurately value your company and, if you rely on the results, lead you to make decisions that are not in your or your company’s best interests.
For example, the pricing multiples these calculators apply to your company’s financial data are generally based on those used to value publicly traded companies. Blindly valuing a relatively small privately held business using the variables applicable to extremely large public companies is unlikely to produce an accurate picture of your business’s value. An appropriate comparison would adjust pricing multiples for many factors, including a company’s size, leverage, profitability, and market share, among others.
What’s more, these online calculators do not attempt to differentiate your business from publicly traded companies with respect to anticipated growth. Remember, the value of an entity is the present value of all expected future cash flows. Those cash flows are typically discounted at a rate that reflects an investor’s required rate of return, given the risks of investing in the company. Therefore, taking into account differentiating factors such as expected growth, market share, and profitability is essential when applying multiples and in valuing a business generally.
Algorithms Don’t Understand Your Business
Finally, factors that are specific to your individual business will affect your company’s value, and no automated program can possibly assess these factors and apply that analysis to the valuation process. Because valuation calculators fail to consider all the above, the likelihood that they will yield a valuation that is even remotely accurate is extremely low.
The only way to ensure that your business valuation is accurate and enables you to make sound decisions for the future is to hire a professional—one who is trained to understand the nuances of the economic forces acting on your company and who can apply that knowledge to the financial and other data at hand. In fact, obtaining anything less than a qualified appraisal produced by a qualified appraiser is likely to do far more harm than good.
Imagine entering into a transaction in which one side—your side—relies entirely on the results of an automated valuation based on a flawed, one-dimensional method. At best, the transaction would fail; at worst, you would sell your company for far less than what it’s worth, without even realizing it.
Everyone wants to receive information quickly, easily, and—especially—for free. However, when the issue is the valuation of your largest asset, hiring a professional is not only prudent, but necessary.
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