Business brokers, business owners, and business appraisers often value the business differently. Business owners, in many cases, are biased in their views towards the firm, and therefore, have an inflated sense of value associated with the business. They value the business simply in terms of what dollar amount they want to realize from a transaction. Business brokers have a vested interest in maximizing the transaction value in order to maximize their fee potential. Their value estimate may differ substantially from the actual fair market value that could be realized in an arms length transaction between a willing buyer and a willing seller. Their value for the business may be based on a rule of thumb or an arbitrary multiple applicable to a measure of cash flow Without a formal valuation of the company, the owners of a small business and the business brokers often have nothing other than a gut feeling or the broker’s calculation of value to support the price for the business. Business appraisers have many methods to value a business.
Usually the final value estimate is determined after considering, for example, an income approach and a market approach. An income approach may utilize a single period capitalization method or a multi-period discounted earnings method, both of which require the calculation of some measure of expected future cash flow. A market approach may use the direct market data method that applies a multiple derived from a statistically significant sample of transaction data to the company’s earnings or revenues. Business brokers, however, typically apply a multiple to the seller’s discretionary earnings. The multiple may range between one and three times seller’s discretionary earnings. However, the misapplication or misinterpretation of seller’s discretionary earnings can significantly impact the value estimate and the potential success of the transaction.