Business Valuation Mistakes

Valuing a business is more complicated than applying a number to annual revenue or choosing the highest multiple available online.

A credible valuation should consider the financial performance, quality of earnings, growth prospects, assets, liabilities, customers, management, industry and risks associated with the business.

Whether you are preparing to sell or assessing a potential acquisition, avoiding common valuation mistakes can help you develop more realistic expectations.

1. Choosing the Highest Multiple

One of the most common mistakes is finding a high valuation multiple and immediately applying it to the business.

A multiple should be supported by evidence from relevant businesses or transactions and adjusted for the characteristics of the company being valued.

A business with lower growth, weaker margins or greater customer concentration may not justify the same multiple as a stronger comparable company.

2. Valuing Revenue Instead of the Business

Revenue indicates how much income a business generates, but it does not show how much of that revenue becomes profit.

Two businesses generating £2 million in revenue can have dramatically different operating economics.

A valuation should therefore consider profitability, margins, cash generation and the sustainability of earnings where relevant.

3. Ignoring Profit Quality

Headline profit may not represent sustainable underlying performance.

A business may have benefited from a one-off contract, unusual income or temporarily reduced expenses.

Conversely, the accounts may contain genuine one-off costs that should be considered when assessing maintainable earnings.

Understanding the quality and sustainability of earnings is therefore important.

4. Making Unsupported Adjustments

Adjusted EBITDA or normalised earnings can be useful, but adjustments should be evidence-based.

Adding back every expense that the owner considers unnecessary can create an unrealistic valuation.

Potential adjustments should be clearly documented and capable of being explained during due diligence.

5. Overstating Growth

Future growth can increase the attractiveness of a business, but unsupported forecasts can damage credibility.

A buyer may examine:

• Historical growth.
• Current trading.
• Sales pipeline.
• Customer retention.
• Market size.
• Competitive conditions.
• Capacity to deliver projected growth.

Forecasts are most persuasive when they are supported by identifiable commercial evidence.

6. Using Poor Comparables

A comparable company should actually be comparable.

Relevant factors can include:

• Industry.
• Revenue size.
• Profitability.
• Growth.
• Business model.
• Geography.
• Customer profile.
• Transaction date.

Using a large listed company as a benchmark for a small owner-managed business, for example, may produce a misleading result.

7. Ignoring Business Risk

Risk can have a significant effect on the valuation a buyer is prepared to accept.

Potential risks include:

• Customer concentration.
• Supplier dependence.
• Owner dependence.
• Regulatory exposure.
• Weak contracts.
• Intellectual-property uncertainty.
• Unstable revenue.
• Operational weaknesses.

A business with predictable earnings and lower perceived risk may command a different valuation from one with similar revenue but substantial uncertainty.

8. Ignoring Customer Concentration

If a large percentage of revenue comes from one or two customers, the buyer may perceive a significant concentration risk.

The buyer may investigate contract length, renewal history, customer relationships and the likelihood that revenue will continue after the acquisition.

A diversified customer base can reduce this particular risk.

9. Ignoring Owner Dependence

Businesses that rely heavily on their owner can be more difficult to transfer.

If the owner personally manages customers, sales, suppliers and day-to-day operations, a buyer may need to account for the cost and risk of replacing that contribution.

Documented processes and an experienced management team can help reduce this dependency.

10. Ignoring Debt and Liabilities

A headline valuation should not automatically be treated as the amount available to shareholders.

Debt, cash and other agreed adjustments can affect the value attributable to the owners.

Other liabilities may also need to be investigated during due diligence.

11. Confusing Enterprise Value and Equity Value

Enterprise value and equity value are different concepts.

Enterprise value generally relates to the value of the operating business before certain financing adjustments.

Equity value reflects the value attributable to shareholders after relevant adjustments.

Confusing the two can result in a seller believing that the entire headline valuation represents the amount they will receive.

12. Ignoring Market Conditions

Business valuations do not exist independently of the market.

Buyer appetite, interest rates, industry trends, economic conditions, financing availability and recent transaction activity can influence what buyers are prepared to pay.

A valuation based on outdated market evidence may therefore need to be reconsidered.

13. Relying on One Calculator

Online valuation calculators can be useful for obtaining an initial indication, but they simplify a complex process.

Different calculators may use different assumptions and methodologies.

A more robust assessment can compare multiple approaches, such as:

• EBITDA multiples.
• Revenue multiples.
• Asset-based valuation.
• Discounted cash flow.
• Comparable transactions.

The relevance of each method depends on the business.

How to Improve a Business Valuation

A stronger valuation process begins with accurate information and realistic assumptions.

Consider the following:

• Prepare reliable financial records.
• Review several years of performance.
• Normalise unusual items carefully.
• Separate recurring and non-recurring revenue.
• Assess customer concentration.
• Identify owner dependencies.
• Review debt and liabilities.
• Research relevant comparables.
• Use realistic forecasts.
• Consider more than one valuation method.
• Review current market conditions.

Valuation Review Checklist

• ✔ Are the financial figures accurate?
• ✔ Is sustainable profit clearly identified?
• ✔ Are adjustments properly supported?
• ✔ Is the selected multiple evidence-based?
• ✔ Are the comparables genuinely relevant?
• ✔ Has growth been supported by evidence?
• ✔ Has customer concentration been assessed?
• ✔ Has owner dependence been considered?
• ✔ Have debt and liabilities been reviewed?
• ✔ Is enterprise value distinguished from equity value?
• ✔ Are current market conditions reflected?
• ✔ Has more than one valuation approach been considered where appropriate?