The Number In Your Head Came From Somewhere

Ask an owner what the business is worth and you will nearly always get an answer. Not a shrug, and not a range. A number, held with some confidence, often to the nearest half million.

Then ask where the number came from.

That second question is the interesting one, because the answer is almost never an analysis of the company. It is a story about something else. And once you know which story produced the number, you can usually work out which direction it is wrong in.

There are six of these, and most owners are carrying two or three at once without noticing they disagree.

One: somebody you know sold

This is the most common source by a distance. A competitor sold, or a friend in an adjacent industry, and a figure went around.

The problem is not that the number is false. The problem is that a headline price is not proceeds, and the two can differ enormously.

The figure that circulates is the announced price. What the seller actually received was that figure minus the part held in escrow against warranty claims, minus the working capital adjustment settled ninety days later, minus the portion carried as a seller note that pays out over five years if the business performs, minus the earnout that may never pay at all. It is entirely normal for the cash that arrives at closing to be sixty or seventy percent of the number people repeat at dinner.

So when you benchmark against a peer's sale, you are usually benchmarking against a gross figure, in a different year, in a different business, sold to a different kind of buyer, and comparing it to what you imagine landing in your own account.

Two: a rule of thumb

Three times EBITDA. One times revenue. Five times seller's discretionary earnings. Every industry has one and they circulate endlessly, because they are easy to remember and they feel like insider knowledge.

A rule of thumb is an average. Averages are useful for describing populations and close to useless for describing one company, particularly when the population is as wide as an industry.

And there is a specific reason the average is the wrong anchor for most owners. The multiple tracks financial performance. Margin, size, growth, consistency. Which means the average multiple describes the average performer, and everyone reading this believes they are above average. Half of you are right. The rule of thumb cannot tell you which half you are in, because it is the same number for both.

Three: somebody wrote to you

You received a letter, or a call, with a number attached. It was flattering, and it lodged.

That number is not a value. It is an opening position, and it was chosen by somebody whose job is to buy your business at a good price for their side. A well constructed opening number is set exactly where it is high enough to keep you engaged and low enough to leave room. It contains real information about the sender's appetite, and it contains no information at all about your company, because whoever sent it has not seen your financials.

An owner who has been approached twice tends to carry the higher of the two numbers as their belief. That number is the more optimistic guess of two strangers, neither of whom had access to your books.

Four: a report prepared for something else

Some of you have a formal number on file. It was prepared for a buy-sell agreement, or for estate and gift purposes, or in connection with a divorce or a partner buyout.

This is the source that misleads the most sophisticated owners, so it is worth being careful about.

That report was almost certainly prepared under a fair market value standard, which asks what a hypothetical willing buyer would pay a hypothetical willing seller, neither under compulsion, both reasonably informed. That is the correct standard for the purpose it was prepared for, and it is a genuinely different question from what a specific, motivated, leveraged buyer will pay for your specific business next year.

Several of those reports were also prepared in circumstances where a conservative number was in your interest at the time. That was not improper. It was responsive to the purpose. But a figure produced to be defensible against a tax authority is not a figure produced to describe what you could actually get, and owners routinely carry the first one around as though it were the second.

Five: an article you read

Industry reports and market roundups quote multiples, and the multiples are usually real. They are also usually drawn from a population that does not include you.

Most published transaction commentary skews toward larger deals, because larger deals are the ones that get reported. A multiple drawn from businesses at fifty million dollars of revenue describes a market with more buyers, more competitive tension, more institutional capital and considerably less dependence on any one person. It does not describe a company at four million.

Six: the number you need

This is the last one and it is the one nobody says out loud.

You worked backward. You know what you need to stop working, or what would make the last thirty years feel like they added up, or what would be fair given what you put in. That figure has a legitimate claim on your attention, because it is the actual purpose of the whole exercise.

It is simply not evidence about your company. And it is the most durable of the six, because the other five can be argued with and this one cannot.

The reason it matters is not that wanting a number is foolish. It is that the gap between the number you need and the number your business currently supports is the single most useful thing you can know, and it is only useful if you know it early. Discovered five years out it is a work plan. Discovered during a sale process it is a disappointment.

What they all have in common

Look back at the six and you will notice none of them is about your business.

The first is about a different company. The second is about an average. The third is about a stranger's opening position. The fourth is about a different question asked for a different purpose. The fifth is about a larger market. The sixth is about you rather than the company.

That is the whole problem, and it explains something owners find puzzling about themselves. You can run a company for twenty five years, know your margins to the point, know your people, know your market cold, and still hold a value figure with no more foundation than a number a friend mentioned in a parking lot.

It is not carelessness. Nobody ever gave you the correct number, because until the day you actually sell, nobody has a commercial reason to produce one.

There is also a reason this is worth revisiting right now specifically. The rules that govern how most small business purchases get financed change on October 1, eight days from today, and issues #23 and #24 worked through what that does to the way a buyer's lender arrives at a price. Whatever number you are carrying, it was formed under the old arrangement.

Where your number actually comes from

The honest version is unglamorous. You take closed transactions in your industry at your revenue size, you find where your financial profile sits inside that distribution, and you make an assessment of how much of the resulting range a buyer would actually hand you rather than hold back.

That is what the estimator does. You answer questions about the business in plain language, it uses real transaction data from your industry and your size, and it gives you a range for a business like yours along with a read on how ready you look today.

Fifteen minutes. No financial statements, nothing sensitive.

Then compare it against the number you walked in with, and pay attention to the direction of the gap. It tells you which of the six you have been carrying.