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Business Planning

Why SMB Owners Undervalue Business Equity

SMB owners make bad decisions because they don’t believe in the value of their business equity. They believe in the value of the cashflows the business generates. They believe in the value of making their own choices about that business. They believe in themselves. But they don’t believe that the equity value of their business will ever actually be there.

I know because I spend my time working with these owners and unless I meet them when they are already in the process of seeking an exit or partial-exit event they never want to consider the full value of their business as an enterprise. This has three primary causes:

  1. They are entrepreneur-professionals who own, run, and deliver at least some of the service inside the business.
  2. They refuse to obtain a third party valuation and instead run on internal assumptions or general rules of thumb for their industry that they know are inaccurate.
  3. They aren’t willing to view something they built as a pure investment and believe that if they consider their ultimate exit they will lose their edge and mentally start down a road they can’t come back from.

The first cause has some validity, as an exit event would likely contain a significant time commitment to assist with the transition and leave capital at risk for a further 1-5 years. Causes two and three are common for entrepreneurs with enterprise businesses but no interest in a liquidity event in the near term.

So why does it matter? In all the cases above these are likely less than $10M revenue businesses and undervaluing equity gets rectified in the time leading up to a sale event when valuation is conducted by transaction and valuation specialists.

It matters because the quality of personal financial decisions made by the entrepreneur is lower and lead to worse outcomes for them and their families. This tends to show up in three areas:

  1. They operate from a place of scarcity and postpone opportunities due to a perceived need to over save.
  2. They tend to take fewer risks to build a larger business because they rely on the ongoing cash flows to provide both current and future lifestyle.
  3. They become calcified in their current business, business model, and lifestyle rather than considering opportunities to exit and make large changes.

Obtaining ongoing business valuations improves both the visibility of the equity value for the entrepreneur but also it’s believably. Including an asset that may comprise 80% or more of their total net worth into decision making creates massive differences. Living their best lives today, taking on new opportunities and challenges, and being willing to make tough decisions when the time comes for a change are all massive opportunities that exist when SMB equity value is accurate and believed.

Jarrod Musick

CFP®

Posted: 07/11/2020

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