9 Myths Around Enterprise Valuation – Now Busted!

9 Myths Around Enterprise Valuation – Now Busted!

Enterprises are built for value. For entrepreneurs, investors, or investment fund companies, eyeing an exit or scaling the businesses to the next level through funding or an IPO is the natural next step. Whatever your strategy – to exit or raise capital or take the financial pulse of your company – the price tag on your business isn’t what you think it is. And that’s a conversation we need to have. While we’re traversing a competitive market in the new digital era, accurate valuation can no longer be an afterthought. Moreover, with interested stakeholders’ judgment clouded by several misconceptions, it becomes equally essential to cut through the noise.
A lot is at stake here. How can shareholders ensure that they’re getting their money’s worth? Let’s bust some myths in the valuation process to encourage businesses to make more informed decisions.

Myth #1:

“Assuming a single valuation determines the sale price of your business.”

Reality:

Valuations are prone to biases and therefore a single valuation may not give the right value for the business. It can, at best, act as a baseline—indicating an approximate price that a potential buyer and seller can agree upon— but it is not a final determinant. Periodic valuations, with adequate checks and balances, can provide a better intrinsic value of an organization. Also, the structure of the deal is as significant as the sale price. (Hint: Do not disclose your valuation to prospective buyers. Only use them to counter the selling price if required.)

Myth #2:

“Revenue multiples are the gold standard.”

Reality:

Valuation can be complex, especially when the selection of diverse models is involved. Revenue multiples are inaccurate as they rarely account for costs, whereas operating income or free cash flows are more critical factors to consider. Opting for the Discounted Cash Flow (DCF) model helps project future cash flows and discount them back to their original value. The result? You can clearly see your net worth based on your earnings.

Myth #3:

“Industry standard multiples exist.”

Reality:

Unlike the assumptions in a business valuation, there are generally no universally accepted ‘standard’ multiples. Businesses are unique in their nuances and risk profiling, often requiring more than a single standard multiple for a fair representation of value. Buyers generally calculate their expected return on investment (ROI) and arrive at the multiple accordingly to align with seller expectations.

Myth #4:

“Historical financial performance is the primary indicator for a firm’s valuation.”

Reality:

Financial attributions of a business are ideally one among multiple key components that determine its value alongside non-financial intangible aspects. Other factors like the strength of the management team, growth trajectory, market position, brand equity, client base, and company culture also affect pricing. Buyers may also take their strategic objectives into account while valuing a business.

Myth #5:

“Complex valuations offer the best value estimations.”

Reality:

Simplicity often triumphs over complex approaches. The number of inputs required for a model is inversely proportional to one’s understanding of a valuation model. The minimal the approach is, the higher its accuracy, and vice versa.

Myth #6:

“Business valuation is solely based on its current performance.”

Reality:

When purchasing, a buyer will analyze an enterprise’s past, present, and future performance. Hence, you must calculate the 12-month trailing estimates alongside the recent financial year data. You also need to consider the firm’s future potential, viability, stability, and predictability of profits.

Myth #7:

“Good revenue and low expenses always equal a higher business valuation.”

Reality:

A strong business valuation isn’t just about good revenue and low expenses—it’s about growing sustainably with strategic investments. On one hand, low expenses might indicate underinvestment in key areas, potentially stunting long-term growth. On the other hand, artificially inflated revenue can create misleading financials. Buyers prefer companies that have a good mix of positive cash flows and future investments.

Myth #8:

“Your business sale should fund your retirement.”

Reality:

Your retirement needs need not necessarily match the value of your business. Business leaders often tend to have a concentrated stock position in their companies and expect a maximal value return when they desire to sell. However, this may be unrealistic and often wishful thinking. The value of your firm solely relies on the perceived value by the buyer.

Myth #9:

“The valuation agreed is the final purchase price.”

Reality:

The initial valuation is merely a starting point. The final transaction price, however, is a complex equation influenced by the deal’s structure taking upfront payments, stock, earnouts, and clawback provisions, as well as the tax implications into account.

Going beyond these business valuation myths and understanding the realities opens up new horizons for entrepreneurs and informed decision-making. A valuation, though, holds significance in determining your company’s net worth and a starting point for negotiations during a sale. Thereby, the ultimate pricing of your business is the point where the buyer and seller expectations meet.

Gain clarity on your business’ value. Consult a qualified business valuation specialist for expert guidance tailored to your unique business needs.