Unrealistic Valuations

Warren Buffett said it best: “Price is what you pay, value is what you get.”

One of the biggest struggles with selling in the lower to middle market is business valuation expectations. The top reason for deals not closing in 2022 was due to a valuation gap in pricing.

Of those transactions that didn’t close due to a valuation gap in pricing, approximately 69% had a valuation gap in pricing between 11% and 30%. Sellers almost always feel their business is worth far more than what the market will bear. Here are a few basic reasons explaining this valuation gap:

• The owner is valuing assets, not cash flows. Investors are not concerned as to what you paid for your assets. A buyer is focused on the cash that the business can generate and its risks. This is especially true with service and technology companies.

• Too often, the owner is not optimizing their value/opportunities due to lack of preparation. A small investment in preparing for the transaction can more than pay for itself if properly executed.

• Owner’s attachment to the Company. If the Company has paid your salary, the children’s tuition, etc., you place more value on the enterprise and may not appreciate the risks associated with the business from an outsider’s perspective.

• Valuations based on the rare astronomical business successes. Examples include Instagram, Facebook and Apple - these entities are so far outside the realm of th norm that any meaningful comparison is ludicrous.

• Private Equity Firms and the relatively low cost of capital have generated an unprecedented frenzy over competing for the companies with an EBIDTA greater than $5 million.

• The owner is equating the valuation based on wants/needs, not on a fair market value.

Before deciding to sell your business, hire an independent, accredited business valuator to provide you with a reality check as well as means of improving the future price.

The Hidden Dangers of Relying Solely on Business Valuation Multiples

Business valuation multiples—like EV/EBITDA, P/E, and Price/Sales—are among the most used tools in finance. They’re quick, easy to communicate, and widely accepted. But while these metrics can offer a useful snapshot, relying solely on them is not only simplistic—it can be dangerously misleading. In valuation, shortcuts are costly. Multiples can guide you, but if you rely on them alone, you’re flying blind.

They Ignore Company-Specific Risks

Valuation multiples assume a level of comparability that rarely holds true in practice. Each company faces its own unique risk profile, including:

• Customer concentration

• Competitive positioning

• Geographic exposure

• Legal and regulatory environments

• Operational resilience

For instance, two companies might trade at similar multiples, yet one could be exposed to a single volatile market while the other has a diversified global footprint. Multiples alone can’t capture these nuances, which can materially impact long-term value.

No Assessment of Management Quality

One of the most overlooked flaws in using only multiples is their complete disregard for management—arguably one of the most critical value drivers in any business.

Strong leadership can be the difference between a company that scales efficiently and one that burns through capital. Strategic clarity, executional discipline, capital allocation, and culture all start at the top. Yet valuation multiples assign zero quantified value to the team steering the ship.

Whether you’re investing in a startup or acquiring a mature business, failing to assess management is a major blind spot.

They Reflect Market Sentiment, Not Intrinsic Value

Because multiples are typically derived from publicly traded peers, they’re inherently reflective of market sentiment—which can be volatile, biased, or outright irrational.

Valuing a private company based on inflated public comps during a bull run, for example, could result in overpaying by a wide margin. Multiples reflect what the market is currently willing to pay, not what a business is fundamentally worth.

They Assume Peers Are Truly Comparable

Even within the same industry, companies can vary drastically in terms of:

• Scale

• Growth rates

• Profitability

• Vendor relationships

• Capital intensity

• Customer base

Applying an average sector multiple to a business without deeply understanding these differences can lead to mispricing. True comparability requires more than a shared NAICS code.

They Overlook Capital Structure and Cash Flow Nuances

Metrics like EV/EBITDA ignore critical elements such as:

• Capital expenditures

• Changes in working capital

• Tax structures

• Debt levels

Two businesses may have identical EBITDA figures, but vastly different free cash flow profiles. Similarly, a highly leveraged firm may appear attractively priced on an EV basis, while hiding significant balance sheet risk.

They Strip Away Strategic and Narrative Context

Multiples reduce complex businesses to simple math. But valuation is more than arithmetic—it’s strategy, story, and judgment. A company’s future prospects, positioning, vision, and innovation pipeline can’t be expressed in a single number.

Conclusion: Use Multiples, But Don’t Be Blinded by Them

Multiples are useful—fast and standardized—but they are no substitute for real analysis. They ignore management quality, gloss over risk, and fail to capture what makes each business unique. For a credible, defensible valuation, multiples should be just one piece of a broader toolkit that includes:

• Discounted cash flow (DCF) analysis

• Scenario modeling

• Strategic due diligence

• Management and operational assessments

Valuing Intellectual Property

Lakelet Advisory Group’s business valuation focus is challenged entities and complex intellectual property (“IP”) assets. Valuing early stage, technology-based intellectual property assets is challenging, in large part due to the difficulty in incorporating the effects of risk and uncertainty inherent in these assets into their valuation. Technology-based intellectual property assets, usually protected as patents and/or trade secrets, are typically valued using the same three common approaches as are used to value businesses or other assets. These approaches include:

1. Income approach

2. Market approach

3. Cost approach.

However, technology-based IP assets pose many unique challenges to a valuation analyst. A few illustrative examples of such challenges include:

• Income approaches are often difficult to implement for a variety of reasons, including the difficulty in quantifying the portion of a product or service’s cash flows that are attributable to the subject IP asset

• Market approaches are often difficult to implement for many reasons, including the fact that IP assets are, by definition, unique. As such, comparable market transactions are often difficult or impossible to find. In addition, because IP assets are not traded on public markets and the transactions themselves are typically confidential, there are few public sources that reveal deal details that would be sufficiently comparable to be used to implement a market approach, and the data available from sources that do exist is often incomplete

• Cost approaches are often difficult to implement because the cost to create the subject assets is almost always unrelated to the value of the asset (e.g., income generation, cost savings, etc.) that can be gained from use of the asset

In addition to these challenges, perhaps the most difficult issue associated with valuing technology-based IP assets is accounting for the significant risks associated with many of these assets. Accounting for risk is particularly difficult in the very common situation when technology-based IP assets are valued prior to any (or significant) commercialization success; i.e., when the assets are “early stage.”

Lakelet Advisory Group would be most interested in assisting you with your challenging restructuring/bankruptcy or intellectual property valuations.

Case Study: The Impact of Poor Estate Planning on a Business Owner's Legacy

Background: John Smith, a 62-year-old majority shareholder in an international engineering firm, unexpectedly died without a complete estate plan. He owned 40% of the firm. John had four children, with only one involved in the business, while the other three had no official role. He was also going through a contentious divorce at the time of his death, complicating asset distribution.

Key Estate Planning Failures: John, despite his wealth, only has a basic will that overlooks crucial aspects of estate planning. Key issues include:

• No plans for business succession, leaving ownership transfer unclear.

• Lack of estate liquidity planning, which means no clear method for paying taxes or debts.

• Absence of asset protection strategies to safeguard business interests.

• No differentiation between heirs based on their involvement in the business, risking conflicts among them.

Consequences of Poor Estate Planning: Since John’s estate was in probate, his 40% share in the firm was frozen, blocking important company decisions. The lack of a clear successor led to governance problems, with disagreements among shareholders and executives on handling John’s shares. His estate faced nearly $6.7 million in estate taxes on his $16.8 million stakes, but his estate lacked enough funds to pay this. Consequently, his heirs had to sell part of his shares at a discount to cover the tax. John’s heirs, which included his wife and four children, unintentionally became major owners of the firm without a buy-sell agreement. Only one child was active in the company, while the other three lacked experience or interest, leading to disputes. The active child wanted a controlling share based on their contributions, while the others wanted to liquidate the business stake. The remaining partners of the firm were reluctant to involve any heirs in management, which created more instability.

John's divorce was not finalized at the time of his death, leaving his ex-wife with a claim to his estate, which further complicated asset distribution and delayed probate. This led to increased legal costs and financial pressure on the company. Due to these legal issues and disputes, the firm's value decreased from $42 million to $32 million in two years. This uncertainty caused client mistrust and loss of contracts, while competitors took advantage of the instability. The family had to sell their shares at a lower price to an external buyer. John's family faced emotional and financial strain, losing control of the business and seeing the value drop. The active child, who had been dedicated to the company, resigned amid conflicts. The four-year probate process delayed access to funds, forcing the family to take loans to cover living expenses.

Lessons Learned & Preventative Measures: Business succession planning suggests that a buy-sell agreement could ensure a smooth transfer of shares to existing partners. Estate tax planning recommends a trust or life insurance policy to cover tax obligations, avoiding asset sales. Liquidity planning, such as setting aside liquid assets or key-man insurance, prevents financial pressure on the business and family. Clear distribution among heirs can be achieved through a family trust, ensuring active involvement in leadership. Divorce-proofing the estate can be done with prenuptial agreements and separate property trusts to safeguard business assets.

Conclusion: John Smith’s failure to plan his estate caused legal issues, family disputes, business problems, and financial losses. His 40% share was sold for less than it was worth, resulting in lower wealth for his heirs. A proper estate and succession plan could have protected his legacy and family wealth while easing business transition. This situation highlights the necessity of estate planning for business owners, particularly those with valuable international assets and complicated family situations.