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Understanding unrealistic business valuations: A common hurdle in M&A transactions

Understanding Unrealistic Business Valuations

Date
05 Oct 2024

Category
Guides & Helpful Tips

Author
Company Becho

As M&A consultants, we frequently work with entrepreneurs looking to sell a business, and one of the most common challenges we encounter is the unrealistic value expectations from sellers. Particularly in India, entrepreneurs tend to develop a deep emotional connection to their businesses having started the same, and nurtured it. This connection, while understandable, can conclude judgement when it comes time to sell the business.
Entrepreneurs invest years, sometimes decades, in building their businesses from the ground up. The effort, sweat, and sacrifices they make often result in a personal bond with their companies. This emotional attachment means they can find it difficult to see their business through a buyer’s eyes. As a result, sellers often expect higher valuations than what the market or financials justify when they sell a business.
One of the key things promoters need to understand is that business value is driven by several factors: market conditions, company financials, profit margins, future growth potential, and the technology they are working with. Having a clear picture of these aspects helps in setting a realistic expectation. However, the challenge comes when we talk about “goodwill.”
Goodwill, the intangible value of a business, is a tricky area. There’s no formula to accurately calculate it, which is why promoters often make the mistake of assigning a disproportionately high value to it. They expect buyers to pay a premium for goodwill, sometimes without realising that unless the business is exceptionally stable, has strong growth potential, or is working with breakthrough technology, buyers are unlikely to pay a high premium.
In fact, only businesses that meet specific criteria—such as a strong and irreplaceable market position, or innovative technology with massive future potential—can demand the kind of goodwill value that some promoters expect. Unfortunately, many businesses don’t fit into this category. Over time, industries change, competition increases, technologies become outdated, and market conditions shift.
Despite these realities, many entrepreneurs still cling to unrealistic valuations, making it difficult to find a buyer. The unfortunate outcome? These businesses often remain unsold, and the only option left is liquidation, which results in lost opportunities for both the seller and the market.
At the end of the day, having a realistic understanding of business value and goodwill when you decide to sell a business is essential for a successful sale. Entrepreneurs must separate their emotional attachment from the practicalities of the market to ensure they don’t miss out on good opportunities.
Understanding unrealistic business valuations: A common hurdle in M&A transactions