April 19, 2011

Of Elephants and Blind Men – Getting to the True Value of your Business

As we have discussed in the past, there are several- SEVERAL different methods of performing a business valuation. Some are more mathematical and precise in nature, while others are more subjective and philosophical. With all of these methods producing potentially vastly different results, getting to the true value of your business can indeed be a […]

So… how do you get around the problem of several different methods telling several different stories about the potential value of the subject business?

Consider the following loose analogy, in which 5 blind men are asked to touch an elephant and describe it.

One man touches the tail of the elephant, and leaves thinking that an elephant is about the size of a broomstick with a tuft of hair on the end of it.

Another touches the trunk, and gets the sense that an elephant is about 6 ft long with a hole at its end.

Another, the ears, along with a different opinion; another, the legs, with a different opinion; another, the side with a different opinion.

If you took the opinions of any one of those men, you can be sure that:

– none of them would be “wrong”

– none of them would have ANY idea of what an elephant looks like.

What’s the key thing missing in this exercise that was given to the men? It is an overall attempt to synthesize the opinions of all of the men , combining them into one informed opinion of what the elephant is really like.

In exactly the same way, the value of a subject business is like the elephant, and the opinions of each of the men are like the results generated by each valuation method. By themselves, each opinion does not necessarily carry much weight; however, combined and considered in their aggregate significance , they create a total opinion of value that individually, they cannot achieve on their own.

By the way- you might often hear about situations where valuation specialists dramatically over- or under-state the value of a business. How does this happen? Simple- the specialists essentially grab the tail of the elephant and assume that it is representative of the entire animal.

It is sometimes due to lack of knowledge; unfortunately, it is also sometimes due to an intentional attempt to mis-represent the value of the business to suit the purposes of the person who hired them.

If you are ever in the situation where you need to have a business valued, be sure to ask the specialist about his methodology of synthesizing the results indicated by different valuation methods. If you get a glassy-eyed look, or are not satisfied with the answer that you have been provided, do yourself a favour and keep looking until you find a specialist who knows how to properly accomplish this. The value of the subject business will be more accurately determined when you find the specialist who practices this important step.

A few thoughts: