[Updated for 2021]
And not knowing your value is eventually going to cause problems.
Throughout thousands of client interactions, one statistic stands out above all others: entrepreneurs drastically overestimate the value of their company. It’s not surprising, of course. It falls right in line with human nature: we all think our house is perfect, no one thinks they have an ugly kid, and owners overprice the asset that they have worked so hard to build. It’s funny – when we sit down with entrepreneurs, they fundamentally realize this – they invariably chuckle along, knowing it’s a fundamental truth.
So what is the big deal of not knowing value?
Well, let’s talk about some other facts: studies consistently show that a company will typically make up over 80% of an entrepreneur’s net worth. For the vast majority, liquidating (i.e., selling) that company will be critical to the success or failure of realizing their retirement goals. That ordinarily wouldn’t be a big deal if that company were a highly liquid asset. If you needed to sell some Google or Facebook stock, you could do that this afternoon. But privately held companies are certainly not as liquid as a publicly-traded stock, and selling one is no sure bet.
More facts: studies show that only 20% of companies successfully sell in their first attempt. That is just an abysmal success rate. The number one reason that companies don’t sell? It’s probably not a surprise: the market won’t support the price that a seller is willing (or able) to sell at. Even worse is the number two reason that companies do not sell: in some cases, there simply is no market for the company – meaning that not a single market participant has found the company attractive enough to enter into negotiations.
Putting this all in context: if you are an entrepreneur, you probably have most of your eggs in one basket. You also probably don’t know what those eggs are worth. And there is only a 20% chance that you’d be able to sell your company successfully… likely because there is a gap between value expectations.
There has to be a better way, right?
Related: Gap Analysis – What is it?
The Value Engineering Playbook
Let’s imagine I want to visit my sweet old Aunt in Schenectady, NY. I’m probably going to need to know at least two things: where I’m starting from and the location that I’m trying to get to. I can’t get on the right roads if I don’t know the starting point, and I’m certainly not going to end up at the right moment if I don’t see the destination. I’d also probably want to know a couple of other things to improve my odds of getting there, right? Like… how far away is Schenectady? Is my car in good shape? Do I have enough gas? But just like you, I’m sure there is a mental playbook that I’d run to get to Schenectady, right?
There’s a playbook for getting to “Schenectady” with a company too. In the life of a business owner, the starting point is your Current Market Value, and the destination is the number you’ve worked out in your financial plan. Is your car in good shape? Right – that’s your company. And gas? Well, that’s probably capital.
Running the table when it comes time to sell will require you to get an accurate insight into your company’s value now, how much of a gap there is between where you are trying to go, and executing a legit plan to close that gap.
Of course, it all starts with knowing the Current Market Value.