8 minute read

Why Business Valuations Vary

Valuation professional reviewing digital documents.

In addition to different business valuation methods, industry trends, market conditions, and unique business characteristics can quickly affect a company’s value. These factors influence pricing, investment decisions, and negotiation leverage for both buyers and sellers. And these factors are especially important for small business owners and entrepreneurs to understand, as they directly impact Main Street business transactions. Potential business owners should consider using a consistent company valuation method, as each offers distinct perspectives on a business's fair market value.

Market-Based Factors

The value of the business depends on many external factors that often influence what buyers are willing to pay and how sellers set their asking prices. For instance, simple supply and demand dynamics directly impact economic value: when there are more buyers than businesses for sale, prices tend to rise. If there are more sellers than buyers, prices go down, giving buyers an advantage. This is particularly evident in local markets, where the availability of similar businesses for sale in the area can significantly influence prices.

Industry trends also matter. For example, a tech startup may be worth more if demand for innovation is high, while companies with a declining growth rate could face a lower book value. Geographic considerations are important too, especially for businesses with local customer bases or unique regional factors.

Enterprise value can also vary based on comparable companies in the industry. While sales data sets helpful benchmarks, differences in timing, location, business size, and data quality can skew insights.

Of course, the economy affects the value of a business as well. In a strong economy, buyers may be more willing to pay premium prices. During a downturn or recession, offers are usually lower.

Business-Specific Variables

Along with market-based factors, unique characteristics can play a role in determining a company’s worth. One area buyers look at is earnings quality. A private company with steady, recurring revenue streams is generally valued higher than one with volatile or one-time earnings. For example, a small retail business with consistent monthly sales may be valued higher than a seasonal business with the same annual revenue. Also, owner salary, any personal expenses run through the business, and compensation for family members can impact earnings quality and should be adjusted in the valuation process.

Companies with a solid growth plan are more attractive to buyers. Alternatively, customer concentration can be considered risky; if a business relies heavily on a small number of clients, it’s a liability if one leaves. This is especially important for B2B service businesses, where losing one major client could significantly impact revenue.

Other aspects that influence the present value of a business also matter:

Strong supplier relationships and a diversified supplier base can add security to operations.
Over-reliance on key employees could deter buyers who worry about potential disruptions.
The value of intellectual property—like intangible assets, patents, trademarks, copyrights, or proprietary technology—can boost valuation, adding to the company's unique advantage in its market.
The age and condition of equipment or other physical assets impact depreciation, valuation, and net asset value.

Buyer-Specific Factors

A buyer's motivation and background significantly impact business valuations. Strategic buyers—typically companies within the same industry—may pay a premium for a merger or acquisition to purchase a company’s assets or real estate to gain competitive advantages. Financial buyers (like private equity firms) focus on future earnings, earnings methods, and returns, often citing a business’s value to be more conservative.

For Main Street businesses, buyer experience level often plays a crucial role. First-time business owners might focus more on stable, turnkey operations, while experienced entrepreneurs might see value in businesses that need operational improvements.

Industry experience also matters; seasoned entrepreneurs may feel more confident taking on niche or small businesses, while newcomers might be skeptical about the intrinsic value due to it being an unfamiliar risk.

Geographic preferences, risk tolerance, and access to financing further shape valuations, as buyers limited by location or cautious about market risks may adjust their offers. Lastly, timeline constraints and post-acquisition plans play a role; buyers on tight timelines or with specific integration goals may adjust their valuation to align with these objectives.

Differences in Business Valuation Methods

Each business valuation method provides a different lens on value. Regardless of the methodology, the goal is to determine the value of the company with an accurate valuation. While all these methods have merit, small business transactions often rely heavily on Seller's Discretionary Earnings (SDE) multiples and asset-based valuations.

Asset-Based Valuation Approach: This method looks at the business’s tangible assets. Variations include valuing assets at balance sheet versus market value and are common for asset-heavy companies or when determining liquidation value.
Market Approach: By comparing recent sales of similar businesses, this approach depends on finding high-quality, comparable data for financial modeling. Differences in industry, location, and timing can impact accuracy and comparability.
Income Approach: Estimating future cash flows, this approach includes the discounted cash flow method (DCF) and market capitalization of earnings. Each interprets earnings stability and growth over a period of time differently, influencing overall valuation.

Common Biases in Valuation

Valuations can be influenced by biases from sellers, potential buyers, and appraisers.

Seller Biases: Sellers often have emotional attachments, leading to overvaluation. They may emphasize future potential, assuming growth that a buyer might not see. They might also focus on historical investments even if they don’t impact future profitability.
Potential Buyer Biases: Buyers can bring their own biases. Confirmation bias is when a buyer interprets information to justify preconceived opinions. Recency bias can lead them to focus on recent performance trends. Lastly, anchoring bias may cause them to fixate on the initial asking price despite seeing other metrics.
Appraiser Biases: Appraisers may be influenced by their past experiences, industry expertise, or regional familiarity. These preferences can subtly shape their approach to determining the value of a company, affecting the final valuation outcome.

Documentation and Information Impact

The quality and availability of a business’s documentation makes a difference. High-quality historical financial statements and records provide a trustworthy view of earnings, expenses, and stability. Detailed operational data, like customer retention rates and supplier terms, can further strengthen buyer confidence. In-depth market research and reliable industry data also provide context for competitive positioning among similar companies.

Understanding and Managing Valuations

A business valuation demands accuracy and strategic alignment. Obtaining multiple valuations offers a range of perspectives and can help sellers and buyers make an informed decision and choose a reasonable midpoint on price.

Working with financial professionals, such as appraisers or business brokers, can clarify complex valuation details, especially in negotiations. All parties must remember that timing also plays a role, since market conditions and business cycles affect valuation results.

BizBuySell has many tools and resources to help you get started on determining the worth of a business—whether you're buying, selling, or just looking for a market valuation: