Business Valuation Bloopers - just a few of the ways it can go wrong
11 March 2016
Bloopers are the mistakes made by cast or crew on a film that end on the DVD extras. Sometimes they can be better then the film. Business Valuation bloopers on the other hand are no laughing matter. You might need a business valuation for divorce purposes, a shareholder exit, or as part of some kind of tax planning. Whatever the reason, whether you’re valuing an early stage technology company in Cambridge, or a mature SME in London there are some common business valuation bloopers to avoid.
As valuation experts we are often get to look at and comment upon other advisers valuation reports. Often basic flaws in valuation methods, logic, or lack of decent data lead to challengeable advice being given.
Here are some valuation out-takes, make sure you avoid them.
"I believe you"
Believing everything you’re told isn’t a good idea. But I see lots of report where advisers have based all of their calculations on profit figures supplied by directors without having challenged them, or having reviewed the business. Sometimes its pretty clear that most of the text is templated and applied to any and every business.
Lies, d*mn lies and statistics
You can find statistics to prove anything – just ask any politician. When valuing a business there a range of indices available from which to source an earnings multiple. The lazy adviser might just reach to for one of these without either questioning it, or corroborating it with other data. This is a problem because these indices by their very nature are averages – and so they say nothing in particular about any one sector or company. It doesn’t matter whether they use, the BDO Private Company Price Index, FT All Share PE ratio, the Leading Edge Alliance’s PERDA, the Argos Soditic Mid Market Index, or the UK200 Group SME Valuation Index, a generic multiple will rarely give you the right answer in a business valuation.
Out of code information
As in any field business valuers need to keep up to date, and to use current data. I recently saw a valuation based solely on the Private Companies Price Index. Just relying on that would be bad enough, but the valuer then applied it to the wrong profit figure in the companies accounts. My guess is he has been using PCPI for years and has never noticed that it changed a few years ago from an EBIT multiple to an EBITDA multiple.
Apples and Pears
Don't mix apples and pears or you'll get a curious byproduct. Likewise there are a range of profit measures, EBITDA, EBIT, PBT, PAT, Operating Profit. And a range of multiples including EV:EBITDA and the price earnings ratio or PE ratio. If you apply a price earnings ratio to EBITDA you will significantly overstate the result.
Rules of Thumb
As a business valuer I wouldn’t disregard rules of thumb in a particular industry, so transactions involving shops, cleaning companies, and professional service firms are amongst those where one comes across them. But I’d only ever use them as corroboration of more rigorous methods. So shops are often sold for a number of weeks turnover plus the value of the stock – ultimately this must also equate to an earnings multiple, but where data might be patchy it’s probably a useful ready reckoner of valuation. The trouble is one often see’s quite inappropriate, and unquestioning, extension of these rules to other sectors. So for example I recently saw a service firm valued by a valuer who I suspect must specialise in valuing corner shops for after arriving at a (not entirely supportable) earnings valuation he then added the balance sheet value.
I could go on. There are lots of ways to go wrong, indeed a quick Google produces an academic paper entitled “110 Common Errors in Company Valuations”
The answer, and you’d expect me to say this, is to find a business valuation expert who knows what they’re doing, and produces a well reasoned valuation that would stand up in court if you ever found yourself there.
Have a look at our http://www.pem.co.uk/corporate-finance/business-valuation
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