Quick Consultant: The Peril of Unrealistic Expectations for Business Valuations

Value, on the other hand, is the total amount that the seller will realize, not only from what he receives from the buyer, but also from what he will retain after settling up all the key assets and liabilities on the balance sheet.

In Dave’s case, he will net an additional $56,000. How? Well, Dave will keep $118,000 in current assets (most cash, savings, and accounts receivable), and and he will agree to assume responsibility for $62,000 in current liabilities (accounts payable, sales tax, credit cards, etc.) Fortunately, there are no long term notes or obligations.

Questionable Receivables &

Payables

If Dave collects all of the receivables and pays off all the liabilities, he will net $56,000. Add this net gain from the balance sheet to what he has been offered for the business ($285,000) and the total value of Dave’s business is $341,000. Dave is actually quite fortunate in this regard since many sellers are upside down when it comes to the balance sheet—owing far more under liabilities than they have due back to the company—especially so after deleting a lot of questionable accounting entries.

Have you borrowed or withdrawn money from the business in the past (with little intention of paying it back) and it now shows up as a long term receivable, which consequently inflates owner equity? If so, you need to consider this when evaluating the the health of your business. So does your accountant!

Let’s look at the other side of the coin. Instead of taking money out of the business, let’s assume you loaned your company $45,000 in 2006 when everything started to slow down and you couldn’t make payroll. Worse, that $45,000 has grown over the past five years and is now $78,000, which appears on your balance sheet under short and long term liabilities as a note payable (with interest) to stockholders for that amount. Once again, you need to check with your accountant as to how this can be cleaned up. If there is little chance that the business will ever be in a position to pay it back, then it would be better to simply write it off on the balance sheet.

Face the fact that most buyers will simply not recognize a note payable to stockholders or owners, nor will they consider notes receivable from stockholders or owners when they appear under current or long term assets. The latter does nothing more than to artificially inflate the total assets of the business. If your company owes you money, then you need to settle that now, not later.

Our Valuation Approach

Below are the figures and logic behind our valuation of $285,000 for Johnson’s Printing & Graphics.

• Gross Sales: $805,000

• Calculated Owner’s Compensation*:

$92,400 - $103,500 (11.5-12.9%)

• Fair Market Salary for Owner/Buyer:

$54,516

• Net Assets to Be Sold: $145,000

• Annual Cost of Net Assets: $14,500

• Excess Earnings: $23,384 - $34,484

• Excess Earnings Multiplier: 4.85

• Excess Earnings X Multiplier:

$113,412

• Recommended Selling Price Range:

$258,412 - $312,247

• Average of Range: $285,330

* Total compensation for one working owner includes profits and salary, perks, benefits, and taxes paid to one working owner. It should never include that amount paid to a working spouse. Cannot include unreported cash. Be very conservative when calculating owner’s compensation. See “Print Shop for Sale” for details.

Space simply does not allow room for a full explanation of the Excess Earnings Approach; the method used to arrive at this valuation. Suffice it to say that, after a careful examination of all the facts, we suggested to Dave that a fair price for his business was $285,330.

Note that I did not say “asking price.” Although we were confident with the $285,330 valuation, we suggested he place the business on the market for $320,000, noting owner financing available. We assumed and anticipated that a careful buyer would make an offer, then the buyer would counter, and finally both parties would end up at this price.

Well, Dave told us all we were crazy. We reminded him that he would also get an additional $56,000 after settling up all assets and liabilities. He left our meeting in a huff and listed the business with another broker for the asking price of $450,000.