In DIY Valuation News: The Internet Lies.

Every once in a while we’ll be chatting with someone about engaging on a valuation project and they decide to go the “DIY” route.  “We decided we’d do the valuation ourselves.”  How did they manage this?  Just like a diagnose all my health problems, of course.  They googled it.

Which brings me right over to this little article that I stumbled upon: “Separating Unicorns from Reality: the Value of Business Valuation.”  Dispensing with the point that the article is just all over the map, they do manage to throw out some valuation formulas, Quoting:

• “Capitalization: most small businesses can figure a multiple of 3 ½ to 4 times gross annual earnings to determine market worth.”
• What businesses similar to yours are worth, usually stated in terms of gross sales times a multiplier.
• Owner benefit. Similar to capitalization, it multiplies one year’s discretionary cash flow times a 2.2727.

Basically my reaction is: whaaaaa?

First of all, there is no one-size-fits-all way to value “most  companies.”  It’s not like buying a hat.  I like to tell people that valuing something – anything! – really comes down to pricing risk.  To the extent that one company (or investment) has a similar risk profile they would have a similar valuation metric.

Second, businesses are simply not usually valued based on a gross sales multiplier.  Sometimes? Sure.  Usually?  Heck no.  Here’s why: Widget Maker A generates $10m in revenues and an annual loss of $2m.  Widget Maker B generates $10m in revenues and $2m in profit.  Other things being equal, would you really pay the same price for A or B?  (If you’re answer is yes come see me after class… I have A’s for sale all day long…)

Finally, “discretionary cash flow times 2.2727?”  That is totally made up.  Seriously, they just wrote down a number with some decimal points and said “sure – let’s use that one.”

Getting to My Point

This was an actual article on the internet.  From a site called Business.com, which one might believe knows something about something.  But if our almost-client were to rely on this article to value Widget Maker A above, they might think their business is worth either:

• A multiple of $10m in revenue
• Negative $7m to Negative $8m
• Negative $4.5454m

So basically- a small range of $18 million in potential value.

The internet wins.