What is your business really worth?

By Pedro Fialho from Value2Exit — financial and legal consultancy specialising in the buying and selling of businesses.

There is a conversation that repeats in almost every sale process of an SME. The entrepreneur arrives with a reference value already defined. Sometimes it results from a multiple heard informally in the market, other times from the amount needed to secure their exit, and sometimes from what they consider fair after twenty years of building the business. Months later, at the closing of the deal, the amount actually received is different.

In most cases, this difference does not result from bad faith on either side. It arises from confusion between concepts that seem equivalent but are not.

Value is not price

The value of a business is an estimate. It results from the cash flow expected to be generated by the business in the future and the risk associated with that expectation. Price is another reality: it is the amount a buyer is willing to pay at a given moment, context, and situation. Between the two are also the conditions of the transaction, that is, the amount paid at closing, the portion dependent on future results, and the guarantees required from the seller.

Two proposals with the same nominal value can have very different economic meanings. One pays the entire price on the signing date. The other pays half and conditions the remainder to an earn-out, indexed to objectives that the seller no longer controls.

There is also a second misconception, perhaps the most relevant. Most valuations determine the value of the business (Enterprise Value), that is, the value of the transaction. The seller, however, receives the value of the equity (Equity Value). Between the two, bank debt, leases, partner loans, and other commitments equivalent to debt are deducted. Cash considered in the transaction is added, and the price is adjusted based on the working capital necessary for the normal operation of the activity. A business valued in several million can, after this bridge, generate for the seller a significantly lower cash inflow than expected. Not due to an unfavourable negotiation, but because those commitments were already on the balance sheet.

The buyer pays for recurring results

Market multiples, discounted cash flow, asset valuation. The methodologies are known, and any rigorous process uses more than one. However, the discussion rarely hinges on the choice of method. It is decided by the quality of the financial information to which that method is applied.

The buyer does not pay for turnover. They pay for the normalised EBITDA, that is, the operating result stripped of non-recurring costs and revenues recorded in the recent history, as well as those not related to operational activity. And they pay, above all, for the part of that result that effectively converts into cash flow. Each adjustment that the seller cannot substantiate with documentation will be contested, and each contested adjustment weakens the credibility of the others.

There is also a factor with a decisive weight in Portuguese SMEs that rarely reflects in financial statements: the founder’s dependency. When the relationship with key clients, the decision-making process, and critical knowledge are concentrated in a single person, the buyer is acquiring a risk. This risk translates into a discount on the price or conditions that require the seller to remain in the business for an extended transition period. The same applies to a concentrated client portfolio or a business with high recurring investment needs.

Selling well starts long before the sale

The good news is that most of these factors can be worked on: separating personal assets from business assets, regularising outstanding liabilities, documenting adjustments to results, structuring an autonomous management team, and diversifying the client portfolio. None of these measures can be implemented in weeks, but all reflect on the price and, above all, on the conditions of the transaction.

The entrepreneur who arrives at the negotiation with organised accounts, mapped debt, and a realistic expectation regarding the value of their business not only negotiates better but also presents themselves prepared for a broader universe of buyers, faces fewer surprises in the due diligence and has greater leeway to reject proposals that do not serve their objectives.

The right question is not, therefore, how much is my business worth. It is how much is my business worth to the person who is going to buy it, and what can be done today to maximise that value.

Are you preparing to sell your business? Value2Exit can help assess the business and compare purchase proposals. Talk to Value2Exit.