The fundamental problem with a business valuation calculator is that it relies on a pre-programmed multiplier of annual profit.
How will a business valuation calculator under-value your business?
ALL online business valuation calculators are pre-programmed to produce the value of a business using data that is easily measurable. Firstly, they ask you to input financial information: profit, turnover, overheads, owner’s salary. Secondly, they input these figures into an algorithm. Thirdly, the algorithm suggests a guide value for your business.
The algorithm, at its heart, is designed to use a ‘multiple’. In simple terms, this is a figure that is multiplied with a sum produced by your financial information. Each online calculator will produce a slightly different sum from the data that you input. Each one will ask for slightly different data. Each calculator will use a slightly different multiple to multiply against your data.
But NO online calculator will ask you for information about the potential buyer of your business. Indeed, it is unlikely that you will know who your potential buyer is at this early stage.
An experienced company seller knows that the true value of a business is in its future potential: “The past was yours, but the future is mine”.
What is the correct way to value a company?
Why do business valuation calculators use a multiplier of profit at all? Probably because this method is capable of being automated online – it requires no regard to the growth potential of a company. It reduces the valuation to an educated mathematical guess.
Business valuation calculators do not have the scope or ability to assess factors that are unique to your business such as: the value of your client base; or the attractiveness of your client base to a potential buyer. Business valuation calculators treat business value as an accounting exercise rather than a sales & marketing one.
How to value a business for maximum gain?
For example, (using an actual business sale that I worked on) a beauty salon in Bedfordshire was making a net profit of £25,000. Using the most popular online business valuation calculator the company owner received a guide sale price between £75,000-£125,000.
Three months later she sold the shares in her company for £250,0000.
How? Because the business owner was able to demonstrate a client base with huge potential to the right buyer. Her salon specialised in treatments for over 50s. It was a desirable business purchase for a chain of female health clubs that wished to access this client base. The chain of female health clubs valued the company based on how much value it would add to its existing business rather than how it had performed in the past.
Why do business valuation calculators produce such wildly differing results to each other?
Because trying to put a value on “reputation” is essentially a subjective exercise. Business valuation calculators have to guess at the reputation value (or goodwill) of a business. There is simply no data they can ask for that will accurately account for this element of a company’s value. In reality, “brand value” is decided by how much the buyer needs to own that brand – this cannot be predicted in advance by an algorithm.
<<SPOILER ALERT>> Business valuation calculators really are as unscientific as this! Business valuation calculators do not work!