If you’re planning to sell your business in the near future, you’re likely to come across all sorts of valuation estimates – many of them based on online calculators. While these tools may provide general guidelines, they often do not apply accurately to small businesses. Unlike large corporations and publicly listed companies, small business valuations follow different principles.
Below are three of the most common small business valuation myths and the realities behind them.
Myth 1: Goodwill is Added to Plant and Equipment/Fit-Out Value
One of the biggest misconceptions among small business owners is that goodwill is simply added to the value of plant, equipment, and fit-out when determining a sale price.
At a high level, a business is best viewed as a single cash-producing asset rather than as separate pieces of equipment plus goodwill. The equipment and fit-out were acquired to generate revenue and maintain profitability. This means that their value is already factored into the business’s cash flow and should not be arbitrarily added on top.
The Risk of Overcapitalisation
A common pitfall for business owners is spending excessively on equipment or fit-out without ensuring that their business generates enough profit to justify the investment.
For example, if a trucking business owns $10 million worth of vehicles but only generates $1 million in profit annually, it presents a poor return on investment (ROI) for a buyer. Most investors would see a 10% ROI as insufficient, especially when compared to lower-risk investment options like stocks or property. In this case, the owner would be better off either increasing profitability to $2.5–3 million per year or selling off excess equipment to align the business value with expected returns.
Important Caveats:
- Industry-Specific Valuation Methods: In some equipment-heavy industries, a rule-of-thumb valuation approach considers the value of used equipment plus one year of profit. However, ROI remains a key factor in negotiations.
- Early-Stage Businesses: If a business is being sold within the first one to two years of operation, the cost of fit-out and setup can sometimes be factored into the valuation, particularly if it is difficult to recoup these costs in the short term
Myth 2: Growth Potential is Factored Into Price
While growth potential is appealing, small business valuations are primarily based on past performance, not future possibilities. Unlike large companies, software startups, or emerging franchises, most small businesses operate within geographical and market constraints.
For example, a local café or retail shop can only expand so much within a given area. A buyer will focus on past profitability rather than speculative growth.
Important Caveat:
In rare cases where a small business is experiencing rapid growth and much of the new profit has not yet appeared in financial statements, some buyers may be willing to pay a premium for that unrealised growth – if they believe it is sustainable.
Myth 3: The Valuation Will Be the Sale Price
A professional valuation provides an informed estimate of a business’s worth based on comparative sales data, but the actual sale price can vary due to numerous external factors. Market conditions, buyer demand, and economic shifts all influence the final settlement price.
For example:
- A business might receive strong buyer interest but still sell at the lower end of its appraisal range if buyers struggle to secure financing.
- Alternatively, a business might sell for above the high-end estimate if a strategic buyer, such as a private equity firm enters the market at the right time.
Market Timing and Pricing Trends
Within the first three months of listing, business owners generally get a clearer picture of whether their business will sell above, below, or within the expected price range. Buyer demand, industry competition, and broader economic trends all play a role in final negotiations.
Need a Professional Business Valuation?
If you’re considering selling your business in North Queensland and want an expert valuation, we can help. Call us on 1300 405 597 or email me directly at kurt@newchapterbusinesssales.com.au.
Have a great week!
– Kurt