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Lesson 2. Ignorance Is Costly
Ignorance -- failure to know what your business is worth -- can be very costly. Several illustrations explain why.
Undervaluing The Business . First let us consider what can happen if you undervalue your business. Let's consider an estate tax case and assume you own a business worth $4 million, but a rule-of-thumb has you believing it is worth just $2 million and your financial advisors have built your financial plan upon that assumption. If you get run over by a truck, you (or more accurately, your heirs) have a big problem.
The current estate tax (combined federal and state) is about 50%, so within 9 months your heirs must pay the government one million dollars. (That is, 50% of the difference between the $2 million you thought your business was worth and the $4 million it was actually worth.) Probably your heirs do not have one million dollars lying around, and so to raise the cash your heirs decide to sell the business. (Too bad if you wanted a family member or a key employee to take over after you've gone.) What is the worst time to sell a business? The answer is: when you have to - when management is in flux and all the likely buyers (namely, your competitors) know the deal must be done under a time deadline of nine months.
Here is a basic truth: if you want to guarantee your heirs sell your business for pennies on the dollar, make sure you UNDERVALUE it.
Overvaluing The Business . This case illustrates what can happen if your overvalue your business. This time you have decided to sell it; again a rule-of-thumb has you believing it is worth $4 million but it really is worth only $2 million. Like most owners, your business is probably your retirement nest-egg. Speaking personally, if I thought I'd have $2 million to retire on but in fact I had only $1 million, I would kind of like to know that before I hung up the "for sale" sign.
And failure to know what the business is worth can kill your chances of selling for a good price. After you post the for-sale sign, you quickly get an offer for $2 million - a very fair price. But because you think your business is worth much more, you conclude this is a "low ball" offer and reject it immediately. Word gets around that you are asking too much, and offers stop coming in. After weeks turn into months and still no more bids, you begin to worry and finally get the business valued. Too late you realize you should have taken the first offer. But by now your business has been on the market for so long, buyers start thinking it is damaged goods. If you sell for pennies on the dollar, you will be lucky.
Basically if you want to guarantee you sell your business for pennies on the dollar, make sure you OVERVALUE it.
