Latest / The Buyer & Seller Podcast with Fexingo: Business Brokers, Exits, and Private Sales Explained / When the Business Valuation Comes Back Too Low
Transcript
- Lucas: You get the valuation report back and it says your business is worth seven million dollars. You were expecting twelve. Now what? Luna: That gap kills more deals than almost anything else I've seen. The seller feels insulted, the buyer feels like they're being jerked around. Lucas: Exactly. And the worst response is to just reject the number and walk away. So let's use a real case. A specialty chemical distributor in the Midwest — around seven million in revenue, very profitable, owner-operated for twenty years. Owner thought it was worth twelve million. Luna: Twelve million on seven in revenue? That implies a pretty aggressive multiple. What was the EBITDA? Lucas: About one point eight million. So the owner was expecting roughly 6.7 times EBITDA. The buyer's valuation came in at seven million total, which is about 3.9 times. Big gap. Luna: And the buyer's report — was it a formal third-party valuation or just the buyer's internal estimate? Lucas: It was a formal valuation from a reputable firm. But here's the thing — the buyer commissioned it. So the assumptions baked in were naturally conservative. The seller had no independent valuation of his own. Luna: That's mistake number one. Never go into a sale without your own valuation. Lucas: Absolutely. But even without that, the seller still had options. The first thing to understand is the three most common sources of valuation gaps. Number one: seller's discretionary earnings — SDE — misinterpretation. Luna: SDE versus EBITDA — that trips up a lot of first-time sellers. Lucas: Right. SDE adds back the owner's salary, perks, one-time expenses. For a small business, SDE can be much higher than EBITDA. But if you're selling to a strategic buyer who will replace the owner with a manager, they don't care about SDE — they care about EBITDA. So the seller was thinking in SDE, the buyer was pricing on EBITDA. Luna: So the seller thought his earnings were higher than they actually were from a buyer's perspective. Lucas: Exactly. The second gap is add-back disputes. The seller had been running a lot of personal expenses through the business — car leases, family travel, a country club membership. He considered those legitimate add-backs. The buyer's valuation gave them only partial credit. Luna: Because if those expenses won't continue under new ownership, the buyer might not value them dollar for dollar. Lucas: Right. The buyer's argument was: some of those expenses are lifestyle, not truly discretionary. They offered a haircut of about thirty percent on the add-backs. Luna: And the third gap? Lucas: Market comparables. The seller pointed to a competitor that sold for eight times EBITDA. But that competitor was in a high-growth metro area, had recurring contracts, and was sold to a private equity roll-up. This distributor was in a rural market, had a few large customers, and was being bought by a smaller strategic. Luna: So cherry-picking comps without adjusting for size, growth, and market dynamics. Lucas: Exactly. So now the seller has a seven-million-dollar valuation and he's upset. What he did next was smart. He didn't reject the report outright. He asked for a meeting to walk through the assumptions. Luna: That's the right move. It signals you're willing to engage, not just fight. Lucas: At the meeting, he came prepared. He had his own analysis of the add-backs, with receipts and explanations for each one. He showed that three of the disputed items were actually ordinary and necessary business expenses — not personal — so they should be fully added back. Luna: Did the buyer budge? Lucas: Partially. They agreed to restore about half of the haircut. That added roughly three hundred thousand dollars to the adjusted EBITDA. Luna: Which at a 4x multiple is 1.2 million in value. Not nothing. Lucas: Right. Then he tackled the market comparables. He found a different set of comparables — smaller distributors in similar markets that had sold for between five and six times EBITDA. The buyer's report had only used large-market comps that were actually lower multiple because they had more risk. Luna: So the buyer's own comps were inconsistent. Lucas: Exactly. The seller presented that data, and the buyer's valuation firm acknowledged they had overlooked those transactions. They revised their multiple range upward slightly. Luna: What did the final price land at? Lucas: Nine point two million. Still below the seller's twelve million expectation, but much closer. And the seller got there by being prepared, not by being emotional. Luna: And if he hadn't done that prep work, he might have walked away from a nine-million-dollar deal. Lucas: Or the buyer might have walked away. Because when a seller just says 'that's too low' without specifics, the buyer assumes the seller isn't serious. And sometimes, low valuations are a test. Luna: A test of seller conviction. If the seller folds immediately, maybe they're desperate. If they push back with data, they're credible. Lucas: Exactly. I've seen buyers intentionally commission a low valuation just to see how the seller reacts. It's a negotiation tactic. The seller who says 'show me your assumptions' is in a much stronger position than the one who says 'that's ridiculous'. Luna: But what if the gap is just too wide? When do you walk? Lucas: Good question. In this case, the seller had a walk-away number of ten million. He didn't get there, but he got close enough that the earnout structure could bridge the rest. They did a two-year earnout tied to customer retention, and if the earnout hits, the total price is ten point five million. Luna: So the valuation gap became a framework for the earnout. Lucas: Right. The seller's conviction about future performance became the basis for the earnout targets. The buyer was willing to pay more if the business actually delivered. Luna: That's a smart outcome. But it only works if the seller has the data to back up his projections. Lucas: Exactly. Which brings us back to the single highest-leverage move: get your own valuation before you list. Not from a broker who's trying to win your listing, but from a reputable valuation firm. Spend five to ten thousand dollars. It gives you a number you can defend. Luna: And it also helps you set realistic expectations. A lot of sellers anchor on a number they heard at a networking event. Lucas: Right. 'My buddy sold his HVAC company for 8x.' Well, that buddy had recurring service contracts in a growing market. Your business is different. A professional valuation forces you to face reality. Luna: Speaking of facing reality — if this episode has helped you think about your own business's value in a more grounded way, I know Lucas and I both feel that conversations like this are worth having. And if it was worth a coffee to you, there's a link: buy me a coffee dot com slash fexingo. Lucas: Yeah, we keep the show ad-free, and listener support is what makes that possible. No pressure ever — just if it moved the needle for you. Luna: Exactly. Now, back to that chemical distributor — one more thing that helped him was having a clean set of financial statements. The buyer's valuation team spent a lot less time on risk adjustments because the books were audited. Lucas: That's a huge point. A clean audit trail reduces the uncertainty premium. The buyer doesn't have to discount for 'we don't know if these numbers are real.' Luna: So the seller's preparation — getting his own valuation, cleaning up add-backs, having audited statements — that directly translated into a higher price. Lucas: Yes. And importantly, it also preserved the relationship. The buyer and seller ended up working together post-close on the earnout. If the seller had blown up over the initial valuation, that trust would have been gone. Luna: So the lesson: when the valuation comes back too low, don't react. Respond. With data. Lucas: Exactly. And if you're a buyer, don't use a lowball valuation as a tactic unless you're prepared to defend it. Because a prepared seller will call you on it. Luna: Alright, that's a good place to wrap. Next time we'll talk about what happens when the buyer's financing falls through two weeks before closing. Lucas: That's a nightmare scenario. We've got a good case on that one. See you next time. Luna: See you.