What to Know Before You Sell Your Company

When it comes time to buying or selling a business, some people take an average of a few calculations and consider it a good way to establish the value of their company. It suprises me how quickly an owner will accept this method when he or she needs to know the company's value.

Can you imagine burning the midnight oil for years, going through the blood, sweat, and tears of building the company, risking everything at times to get the business to the next level only to rely on an average of a few calculations when it comes time to cash it in? Isn't it worth finding out what the business is really worth? Both buyers and seller can leave a lot of money on the table because they rely on an average of a few calculations.

Here are a few examples of what can happen if you rely on an average. A service business with few tangible assets like a website design business would likely see calculations based on tangible assets and calculations based on income production show a large difference in value. If the value from an asset calculation gave an indication of value of $40,000 and the income calculation gave an indication of value of $250,000, the average would be $145,000. The difference between the two is $210,000.

Using an average for a company with heavy equipment can also be problematic. The value from an asset based calculation could be vastly different than the value from an income based calculation. Let's assume the current market value of the assets was $1 millon, and the income based calculation gave us a value of $150,000. The average of these two amounts is $575,000. The difference between the two calculations is $850,000.

In IRS revenue ruling 59-60, the author couldn't have said it better when he wrote, "Depending upon the circumstances in each case, certain factors may carry more weight than others because of the nature of the company's business. No useful purpose is served by taking an average of several factors and basing the valuation on the results. Such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance."

If a customer came into your business and told you the company was the worst of the best companies in your market or the best of the worst companies in your market, wouldn't you be a bit upset? Would you believe him? Yet this is precisely what you are saying when you use an average to calculate your value. The definition of average is the best of the worst or the worst of the best.