Everyone has their expertise. The key for any buyer is identifying what that skill is, and marrying it to the right business.
In a prior post, I alluded to the fact that good businesspeople know their strengths while great ones know their weaknesses.
A situation arose this week that not only reinforces how critical it is to buy a business that can leverage your strengths, but also, how you need to have the right experts on your team doing what they are good at, and not what they think they are capable of contributing.
Why is it that some professionals feel this need to step completely outside their area of alleged expertise, and offer opinions on subjects which they are in no way qualified to do?
Let me tell you what the catalyst was for the prior paragraph.
This past week, a client emailed me because she and the seller ran into a major roadblock. They had previously agreed on a valuation for the business, and were working out the final deal terms. Their basis was a multiple of the Owner Benefits which is the proper way to value the business, and I fundamentally agreed with the valuation they had mutually agreed upon. So far, so good – but not for long.
In comes the buyer’s accountant and derails the entire deal.
Why?
Because according to the CPA: “that is not the way to do a business valuation”. In the opinion of this genius, you need to strictly take the Net Income plus the value of the assets and any excessive personal perks and bingo, that is what the company is worth. End of story. He further suggested that depreciation should never be added back, no matter what, and moreover, the buyer needs to further reduce the amount by the cost to hire a manager.
Wrong! Wrong! Wrong!
This stuff makes my blood boil.
There is no doubt that depreciation cannot be an automatic add-back without a corresponding reduction for future capital expenditures in many cases and clearly, this is not how many businesses are often represented which is misleading.
However, the concept of reducing the basis of the valuation by the cost to hire a manager is completely ridiculous.
Yes, it is an exercise a buyer should do strictly to measure their potential return versus other investment opportunities, but not to determine the valuation of an owner-operated business that the buyer will be running.
Additionally, while I hate to use the word “typical”, it is exactly that for an accountant to suggest that the assets of the business play such a robust role in the valuation – they don’t. Assets are a means to drive revenue. They are a vehicle to obtain financing. They play a role only as it relates to adjusting the valuation to accommodate their replacement as I mentioned earlier. That’s it. That’s all.
The issue of assets should be taken in this light: Is a business with new assets that is not making any money worth more than a highly profitable business with older assets? I think not. If your accountant has a different opinion, send them over to me any time – I welcome the debate.
I am the biggest proponent of using a number of different valuation methods to get a general parameter of a valuation and a sanity check because this is not an exact science. But, I simply cannot grasp the idea of trying to apply an archaic textbook theory to a very different real-world.
It reminds me of when I ask someone what is it specifically that qualifies them to run a particular business they may be considering and they tell me: “Because I have an MBA”. Well that’s great I tell them; a degree like that is impressive and it certainly helps to get a job; but what it has to do with the skills necessary to successfully operate a business is beyond me. At that point, I like to remind them that Bill Gates, Richard Branson, Rachael Ray, Russell Simmons and Barry Diller to name a few, never even graduated from college. Or that Michael Eisner had no idea how to even read a financial statement when he first took over the helm at Disney.
The point is that acedemia and the real-world do not always mix.
While I have the utmost respect for the accounting community and they clearly play a very important role in the buying process, they are not trained, nor are most of them experienced, to perform the valuation of a small business in the real world.
They generally pay too much attention to the balance sheet, while it is the income statement that drives small business valuations.
I do not want to paint the entire accounting profession with the same brush of course.