Everybody knows that the first step to selling a company is to get a valuation.  Trouble is, that valuation may not be worth the paper on which it appears.  A fair market valuation does not necessarily tell you what is the highest price you can expect from a sale.  Instead, it represents what a typical buyer would pay.  As the seller, do you really care what the typical buyer will pay?  That may satisfy your curiosity, but what you really want to know is how much will the highest buyer pay.

Here is where theory collides with reality.  The textbook definition of fair market value is “the amount at which property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts.”  Shannon Pratt, the guru of business valuation, explains that the willing buyer and willing seller are hypothetical persons, rather than any particular buyer or seller.  In other words, the typical valuation would exclude consideration of a particular buyer who is especially motivated to pay a higher price.

Without intending any disrespect to Shannon Pratt, we don’t know any informed sellers who are willing to sell to the typical buyer.  If they have made it very far in business they will know that the trick is to sell to the buyer who is offering the highest price, not the average price.  Ignoring non-financial considerations, why would any seller be willing to sell to the typical buyer when there is another buyer who will pay a premium? 

Recently I advised an estate on selling a company that had been appraised for estate tax purposes.  When it came to actually selling the company, the valuation was practically worthless to the estate because it ignored consideration of a key strategic purchaser who was paying a premium for similar businesses.  As the estate’s representative said to me, “Who cares that a hypothetical buyer will pay $8 million when a real buyer will pay $10?

Business valuation has its proper place, but it is clear that most business appraisers have never actually sold a business.  Real sellers don’t care much for hypothetical buyers.  Owners of middle market companies are well advised to search for strategic purchasers who, due to synergies or other reasons, will pay more than a financial buyer.  As we have said on many occasions, selling a business is about selling to the right buyer, not any old buyer.

Does this mean that you should never get a valuation before selling?  Not exactly.  Some sellers think they need a valuation from an appraiser instead of their investment banker because the investment banker may be motivated to place a modest price on the business.  If this is your concern, you should ask your investment banker to give you a general idea of expected value before you commit to an engagement.  If the indicated value is insufficient, you can consult with other investment bankers or suspend the sales effort.  If you must have a second opinion, consult with another investment banker or a business appraiser who knows the market.  Avoid business appraisers who are not familiar with the market for your business.  You won’t know whether the valuation they give you is theoretical or real!

Back to Articles