If you ask a business appraiser why clients show up, you will hear that there is some type of business transaction that drives the need for business valuation.
Rarely do business people spend money on a business valuation just out of curiosity. The situation is similar to getting your personal or real property appraised.
Why appraisals are essential – avoiding asset overpricing or underpricing
If you are looking to buy or refinance your house, you would need to appraise the property to get the loan or make sure the asking price is realistic. Your lender would want to know that the house offered as a collateral for the loan is worth the money. As well, you would want to know that the asking price for a house you are considering is in line with the market rates.
If the price is right, you can feel good about making a fair offer. If not, especially in the case of for sale by owner or FISBO sellers, you may need to resort to negotiating the price if you still want the house. Your ability to convince the seller to come to a reasonable compromise can make or break the deal.
Either way, there is tension in the air as the buyer and seller come from two opposite directions. The buyer wants to pay the lowest price possible. The seller looks for the highest selling price the market will bear. It can get quite intense in the heat of negotiations.
Overshooting the asking price can land the seller in trouble as the house languishes on the market with no serious offers. Buyers get a sticker shock and look elsewhere. The overpriced house does not sell, until the seller comes around and lowers the price.
On the other hand, the valuable asset that is seriously under priced may fly off the shelf, but leave sour taste in the seller’s mouth. Just consider all that money left on the table.
The situation gets even more serious with business valuations. For one thing, businesses do not sell nearly as often as homes or cars. In addition, no two companies are the same. Just finding the right buyer for a business is a major project.
Dumb money in business buying – how to wreck successful companies
Anybody with money can in theory buy a house and occupy it without difficulty. But assuming that any buyer with money is a good candidate to buy your business is a bad idea. Whether the buyer is capable of taking over the company is by no means obvious. You may see your life’s work driven into the ground by an incompetent new owner shortly after the business sale.
Reserve seller financing for qualified business buyers
This concern over the future prospects of the business is one key reason business owners are reluctant to offer seller financing. A chunk of the business selling price may depend upon the new owner’s ability to run the business successfully after the purchase. If they fail, the seller is out of money and often needs to regain control of a failing company.
So in addition to business valuation, transactions often require due diligence to maximize the chances of successful ownership transition.
A solid business appraisal is very helpful here. In your business valuation report, you describe your company, its value drivers, competitive position, and future prospects. Your buyer candidates need to understand what they are up against if they decide to move forward with an offer.
No 1 reason for business failure – under-capitalization
The business selling price and terms are key to a successful sale. One important question that must be addressed is whether the new owners have sufficient capital on hand to both fund the purchase and cover the cash flow needs for operating the business. Under-capitalization is perhaps the greatest danger the new business owner faces.