A primary sticking point for buyers and sellers is the value of a business. Overvaluing or undervaluing a business means one side loses out, with enormous financial consequences.
Buying or selling a business can grow your market share or enable you to execute a seamless exit strategy. One of the primary sticking points for buyers and sellers is the value of the business. Overvaluing or undervaluing a business means one side loses out, with enormous financial consequences.
According to the Exit Planning Institute, approximately 75% of owners said they regretted selling their business after completing a sale for one reason or another. The last thing you want is to be left with a bitter taste in your mouth after a merger or acquisition. In this guide, we discuss undervaluing a business and the potential risks.
What does undervaluing a business mean?
Undervaluing a business means assuming a firm is worth less than it actually is. Depending on whether you’re buying or selling, this is either an advantage or a disadvantage. Investors purposely search for undervalued businesses to snap up a bargain, whereas business owners must avoid this fate.
Why might a business be undervalued?
Undervaluing businesses happens all the time for one reason or another. The fact is that many managing directors are unable to provide an objective assessment because they can’t see the forest for the trees. That’s why it’s vital to consult an expert who can provide a realistic assessment of a company and its worth.
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What factors negatively impact a business valuation?
Countless factors could negatively impact a business’s valuation. Simply catching a business during a moment of pressure could result in a valuation that’s far below its true worth and potential.
Examples of factors that could negatively impact a business valuation include:
The process of selling a business usually happens years in advance to address factors that could act as headwinds for a bumper business valuation. Thankfully, most factors that could negatively impact your valuation can be addressed.
The risks of undervaluing a business
The UK M&A industry is experiencing a boom as the stars align for deals. According to PricewaterhouseCoopers, deal values jumped by 37% in 2024, indicating an attractive market for investors.
Undervaluing your business means you’re giving someone else a bargain. Going through with a sale of a business that has been undervalued means you fail to maximise what you have, resulting in significant financial loss for you and any shareholders.
Moreover, even if you’re not selling your business, commissioning a valuation and undervaluing the business sends the wrong signals to investors, customers, and suppliers. It creates the perception of weakness and may even dilute ownership if you decide to raise capital through external investment.
In short, you open yourself to being taken advantage of by opportunistic buyers. In the worst-case scenarios, it could even result in hostile buyers seeking to initiate a hostile takeover. An aggressive acquisition of an undervalued business undermines your negotiation leverage, leaving you at the mercy of whoever wants to buy.
In all cases, business owners looking to sell are at risk of immense financial loss if they undervalue their organisations.
It’s also worth mentioning that if you sell for significantly less than your business is worth and the company enters insolvency within two years, it could trigger the Transactions at an Undervalue (TUV) process, which could result in personal liability for the sellers for failing to act in the best interests of the company and its creditors.
Mitigating risks of undervaluing businesses
Undervaluing a business leaves money on the table if you’re selling, and creates false perceptions of weakness if you seek additional investment. Getting a competitive yet realistic valuation means doing what you can to mitigate the risks and maximise the final figure.
Here’s how to mitigate the risks of undervaluing your company.
Use multiple valuation methods
Fair market values rely on using the most suitable valuation method. Using the incorrect valuation method can result in an undervaluation or even an overvaluation. Examples of valuation methods to deploy include:
Organise and maintain financial records
The crux of any valuation is your financial records. If financial records are missing, lost, or even hidden, it’s impossible to get an accurate valuation. You should have profit and loss statements, cash flow reports, balance sheets, and your latest HMRC tax filings.
Factor in intangible assets
A company’s value goes beyond its cash and equipment. Intangible assets can be just as valuable as the assets you can touch. Examples of intangible assets to highlight in a valuation include:
Improve operational efficiency
Businesses that struggle with efficiency or lack the ability to scale effectively may be undervalued because they are not in the best position for growth and may be exposed to future risks. Anything you can do to streamline the business will have a noticeable impact on your valuation.
You might decide to invest in automation to improve productivity. You could improve your management team to reduce the dependence of the business on a single owner. Alternatively, you might implement cost controls to widen your margins.
Develop your growth strategy
Investors don’t buy businesses intending to stand still and run them in the same way for eternity. Buyers want to see the growth potential. Focus on developing medium and long-term growth strategies, even if you don’t intend to be around when those plans are realised.
Growth strategies indicate proper succession planning and mitigate the risk of being seen as a stagnating business, which is a negative influencer on valuations.
Hire a professional valuation agent
Finally, hire a professional to value your business. Few managing directors are experts in the process of formal business valuations. Even if you are, hiring a professional is always best because they can guarantee total objectivity.
At Hilton Smythe, we support businesses in commissioning realistic valuations that reflect the authentic value of UK firms. We can also consult with you to prepare your business for an upcoming valuation to ensure it isn’t undervalued. To find out more about our array of valuation services, contact us now.