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What are the risks of overvaluing or undervaluing a business?

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Dangers of overvaluing or undervaluing a business

When it comes to the sale of a business, a business valuation is one of the first steps. This is to calculate the market value of the business and then use this information to make an informed pricing decision. A company valuation is performed by a qualified business valuer with access to data on how much similar businesses sold for, a golden nugget of information that can help minimise the risk of overvaluing or undervaluing a business.

Overvaluing a business - what does it mean?

Overvaluing a business means overestimating how much it is worth.

This can result in a host of complications, such as unrealistic expectations for a payday that’s likely to be less than expected. This could scupper your financial plans for life post-sale as the returns from your investment may not reflect those forecasted.

The discrepancy between the valuation report and how much the business is worth can mislead potential buyers which can be difficult to justify, leading to potential disputes.

A valuation of a business may be partly based on growth promises and growth forecasts, so it’s important to understand that it could be subject to change.

If you wish to then disengage with your business transfer agent as you’re failing to attract buyers, you’ll likely lose your sign-up fee if you’ve paid upfront.

Undervaluing a business - what does it mean?

Undervaluing a business means overestimating how much it is worth.

How much you are likely to generate from the sale of a business will shape your financial plans post-sale, your investment decisions, and the grandiosity of these plans. If the business is worth more than the valuation report reflects, this could greatly modify the plans of the business seller once the business is sold and put the seller at a disadvantage for putting a business up for sale for less than it’s worth.

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What factors impact a business valuation?

A business valuation is impacted by numerous factors that could either increase or decrease the market value of a business, such as:

Valuation method – The technique used by a business valuer to value a business will have a direct impact on the valuation of the business. A business valuer will responsibly choose the best valuation method to work out the accurate value of the business. Many methods can be used to value a business, such as price-to-earnings ratio, entry cost or discounted valuation.

Comparable sales data – The business valuer must have access to a whole bank of similar sales data to calculate an accurate market value for the business. A data point as such provides deep levels of insights that can be used to draw comparisons between businesses due to go up for sale, and those that have successfully sold.

Expertise of business valuer – The hands-on expertise and knowledge of a business valuer are essential as it adds value to the business valuation process. Their understanding of the local marketplace can help quantify the value a business holds to the local community and its customer base.

Features of the business – The features of the business, from the location, physical premises, and equipment, to profitability, company liabilities, and assets, will ultimately contribute towards its market value. How much buyers are willing to pay for the business is another factor that’s likely to contribute towards its worth.

Business growth – Prospective buyers will always have their eye on the future and the growth potential of the business.  This is where forecasts are helpful as they can indicate if a business is on track to hit new records and build a bright future.

Undervaluing or undervaluing a business poses a real threat to sellers and buyers alike and can have financial implications. As such, it’s vital to appoint a business transfer agent that’s knowledgeable and has demonstrable experience. For more information on valuing a business and the dangers of undervaluing or overvaluing, get in touch with a member of the Selling My Business team of business brokers.

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