Lessons Learned from Buying a Business: Why Fair Valuation Matters More Than You Think
Buying a business is a complex process with many potential pitfalls. Over the years, I have purchased several businesses, both with and without the help of SBA lending. Along the way, I have learned some invaluable lessons — sometimes the hard way. On our first acquisition, we made a costly mistake: we overpaid by $500,000 because we did not appropriately account for the replacement salary of the owner. While we are managing to cover our debt, our cash flow margins have been tighter than anticipated since the acquisition. This experience taught me a critical lesson: no matter how educated or experienced you think you are, you should always hire outside experts for financial due diligence and business valuation.
This article will explore the importance of obtaining an independent and accurate business valuation before purchasing a business, especially when SBA lending is involved. I’ll share what I’ve learned from valuing businesses for SBA purposes and provide insight into why relying solely on the valuation hired by an SBA lender can be risky. If you’re considering buying a business and want to ensure you make a sound investment, reach out to Peak Business Valuation at https://peakbusinessvaluation.com/contact-2 or call 435–359–2684. Our team is here to provide an objective, reliable valuation that serves your best interests.
The Costly Mistake of Overpaying for a Business
When we bought our first business, we believed we were getting a fair deal. We trusted the valuation provided by the SBA lender, which came in $250,000 higher than our purchase price. At the time, this seemed like a positive sign — it suggested that we were getting the business for a good price. However, what we didn’t realize was that the valuation didn’t properly account for all the necessary expenses, such as the replacement salary of the owner. This oversight led to us overpaying by $500,000.
Why Overpaying Is Dangerous
Overpaying for a business can have serious consequences. When you pay more than the business is worth, you immediately put yourself at a disadvantage. You may find yourself burdened with debt that eats into your cash flow, making it difficult to cover your operating expenses and service your debt. This increased financial strain can limit your ability to invest in growth opportunities, hire new staff, or weather unexpected downturns.
In our case, the impact was clear. While we managed to cover our debt, the cash flow margins were significantly lower than before we bought the business. This situation created stress and limited our options for future growth. It was a stark reminder of why it’s essential to understand the true value of a business before making an offer.
The Role of Business Valuation in Protecting Your Investment
One of the key lessons I’ve learned from buying businesses is the importance of a thorough and independent business valuation. A professional valuation provides an objective, comprehensive analysis of a company’s worth, taking into account all relevant financial, operational, and market factors. This information is crucial for making informed decisions and avoiding costly mistakes.
Why Relying on SBA Valuations Can Be Risky
Many buyers rely on the business valuation commissioned by their SBA lender to determine the purchase price of a business. However, not all SBA business valuations are created equal. In my experience, I’ve seen valuations that come in significantly higher than the actual fair market value of the business. This can happen for several reasons, including differences in valuation methodologies, assumptions, or even conflicts of interest.
When an SBA lender hires a valuation firm, the primary goal is often to facilitate the loan process. While this is important, it doesn’t always align with the buyer’s best interest. An inflated valuation can lead to overpaying, which, as I’ve already mentioned, increases the risk of financial strain and potential business failure. At Peak Business Valuation, we conduct valuations for SBA lending purposes regularly — valuing 15–20 businesses a week — and our focus is always on determining the fair market value of the business, regardless of the purchase price.
Why Independent Business Valuations Are Essential
To ensure that you are making a sound investment, it’s essential to obtain an independent business valuation from a firm that prioritizes accuracy and objectivity over the convenience of the lending process. Here’s why:
1. A Fair Market Value Perspective
At Peak Business Valuation, our goal is to determine a fair market value for the business. We could care less about the purchase price. If our valuation comes in higher or on par with the purchase price, great. But if it comes in lower, there is usually a good reason. A lower valuation may point out risks or challenges that have been overlooked by the buyer or seller, such as declining market trends, outdated equipment, or unrecorded liabilities.
When our valuations come in lower, brokers often aren’t happy. This makes sense — they are incentivized to close the deal quickly and at the highest price possible to earn their commission. Similarly, the SBA Business Development Officer (BDO) might be concerned because their commission is tied to the loan closing. However, it is essential for the bank to seek a valuation that is fair and covers its risk in making the loan. The lender must also ensure that the valuation is fair to the borrower, protecting them from overpaying and taking on excessive debt.
2. Protecting Against Overpayment and Debt Burden
The easiest way to kill a business is to overpay and burden the company with debt. Excessive debt increases the risk of default and limits the ability of the business to operate effectively. When the debt service is too high, the business may struggle to meet its obligations, pay employees, or invest in growth opportunities. This scenario is particularly dangerous for new business owners who may not have the experience or resources to manage financial stress effectively.
As a buyer, you should be pleased when a valuation comes in lower than expected. It often means that the valuation firm has identified risks or issues that you may have overlooked. This information can help you negotiate a better purchase price or decide whether to walk away from a potentially risky deal.
The Importance of Hiring an Independent Valuation Firm
When it comes to obtaining a business valuation, independence is key. An SBA lender should always hire an independent valuation firm that is not incentivized to inflate the value of the business to facilitate the loan. Here are some of the reasons why independence matters:
1. Unbiased and Accurate Valuations
An independent valuation firm is not influenced by the desire to close a deal or earn a commission. Instead, its sole focus is on providing an accurate and objective assessment of the business’s value. This independence ensures that the valuation is based on facts, not assumptions or interests that may not align with the buyer’s best interests.
2. Transparent Valuation Process
An independent valuation firm will use a transparent process, outlining the methods and assumptions used to arrive at the final valuation. This transparency provides confidence to all parties involved — buyers, sellers, lenders, and investors — that the valuation is credible and reliable. It also allows for better decision-making based on a clear understanding of the business’s strengths, weaknesses, and potential risks.
3. Expertise and Experience
Hiring an independent valuation firm ensures that you have access to professionals with expertise and experience in valuing businesses in your specific industry. These experts understand the nuances of different sectors and can provide insights that a generalist might overlook. Their experience can help you navigate the complexities of business valuation and make more informed decisions.
How to Ensure You’re Getting a Fair Valuation
If you’re considering buying or selling a business, here are some steps to help ensure that you receive a fair and accurate valuation:
1. Choose an Independent Valuation Firm
Make sure the valuation firm you choose is independent and has no conflicts of interest. Look for a firm that is experienced in your industry and has a track record of providing objective, reliable valuations.
2. Understand the Valuation Methodology
Ask the valuation firm to explain the methodology they will use to value the business. Make sure you understand the assumptions they are making and the data they are using. A credible valuation firm will be transparent about its process and willing to answer your questions.
3. Look Beyond the Numbers
Remember that a business valuation is about more than just the numbers. It should also consider qualitative factors, such as the quality of the management team, the company’s competitive position, and its growth prospects. Make sure the valuation firm takes a holistic approach to assessing the business’s value.
4. Use the Valuation to Inform Your Decision-Making
Use the valuation report as a tool to inform your decision-making, not as the sole determinant of the purchase price. Consider the insights provided by the valuation and use them to negotiate a fair price, assess risks, and plan for the future.
Conclusion: Don’t Leave Business Valuation to Chance
Having bought several businesses, I’ve learned firsthand that business valuation is too important to leave to chance or guesswork. Whether you’re using SBA lending or financing the purchase yourself, it’s crucial to have an objective, independent valuation that provides a clear picture of the business’s worth. This helps protect you from overpaying, reduces your risk, and ensures that you are making a sound investment.
At Peak Business Valuation, we are committed to providing accurate, independent valuations that serve your best interests. Whether you’re buying or selling a business, our team is here to help you make informed decisions and achieve your financial goals. Reach out to us at https://peakbusinessvaluation.com/contact-2 or call 435–359–2684 to learn more.
