Industry
Part of Why does a valuation calculator's multiple describe a deal instead of pricing one?
Which kind of valuation calculator service are you using?
A valuation calculator service is a lead magnet, a subscription database or an appraiser's model. Each has a different ratio source and a different owner.
A figure from a valuation calculator is only as meaningful as the kind of service behind it. These services fall into three kinds, and the interface looks much the same from one to the next while the business model behind it does not.
Each kind handles your inputs differently. Judge each against what it is, not against the others.
What to take away
- There are three kinds of calculatorthe lead magnet, the subscription database and the appraiser's own model. The interface does not tell you which one you are using. The business model does.
- A lead magnet is a pitch, a database can be traced to data, and an appraiser's model is the only kind where a person checked your inputs.
- Put one question to each kind before you pay or hand over contact details.
- No calculator replaces the accountant who builds the figure from the record. A sale of this size warrants an intermediary, an accountant and a lawyer.
The lead magnet: free, and you are the product
A lead magnet is a free form on an intermediary's, lender's or adviser's site, built to start a conversation. BizBuySell and BizEquity are the best known. The figure it returns is part of the marketing, and pitches run high.
That does not make it dishonest. It makes it a pitch. Judge it by what happens after the figure appears. If the next screen asks for your contact details, you have identified the product, and it is you.
The question to ask is who operates the tool and why. If an intermediary runs it, read the engagement letter clauses before you sign anything that follows from the figure.
The subscription database: traceable, if the data is good
A subscription database is a paid tool, often used by intermediaries and appraisers, that draws on recorded transactions. DealStats, formerly Pratt's Stats, and Bizcomps are the names to ask for. It is the only kind whose ratio can be traced to data.
Its usefulness depends entirely on that data: whether it records completed deals or listings, how recent they are, what size of business they cover, and whether the terms of each deal are known. Judge it by asking those questions and reading the answers.
The question to ask is what the data covers and when. A database that cannot say has a ratio you can trace to nothing, whatever the price of the subscription.
The appraiser's model: a person stands behind the figure
An appraiser's model is not a website at all. It is a spreadsheet or method that a qualified person applies to your records after examining them. It looks like a calculator and is not one, because the inputs were produced by someone who checked them.
Judge it by the person. Look for their credential, an ASA, a CVA or an ABV, or a CPA who performs valuation work, and ask whether they will stand behind the figure. For a database, nobody does. For an appraiser's model, the appraiser does, and that is what you are paying for.
The three kinds side by side
| Question | Lead magnet | Subscription database | Appraiser's model |
|---|---|---|---|
| Where the ratio comes from | The operator, rarely shown | Recorded transactions | The appraiser, from your records |
| Who checked your inputs | Not checked | Not checked | The appraiser |
| Who stands behind the figure | No one named | Nobody | The appraiser |
| What to ask first | Who operates it and why | What the data covers, and when | Their credential and what they will sign |
The mechanism is the same in all three: an input scaled by a ratio. The difference between the kinds is where the ratio came from and who is liable for it.
Pass-or-fail tests once you know the kind
Once you know the kind, test the tool itself. The first three tests ask whether the tool shows its ratio, names its data and states which earnings definition it expects, seller's discretionary earnings or EBITDA.
Rubric for judging valuation tools
- Shows the ratio it applied
- Names its data and period
- States earnings definition expected
- Asks about durability of earnings
- Explains what it cannot see
- Says who operates it and why
- Handles your data plainly
A tool that passes the first three is unusual and worth ten minutes. One that fails them all is producing a figure whose only purpose is to be attractive. A lender will test the earnings behind any figure anyway, as acquisition financing mistakes show.
What the ratio is hiding
Whatever the kind, its ratio compresses two things a buyer weighs separately. One is the time value of money: profit next year is worth less than profit now, and the ratio assumes how much less.
What the hidden ratio compresses
Time value of money
- What it weighs
- Profit later vs now
- Assumption made
- How much less
- Shown to user
- No
- Based on
- Average of others
Risk premium
- What it weighs
- Profit that may stop
- Assumption made
- How likely to stop
- Shown to user
- No
- Based on
- Average of others
The other is a risk premium: profit that might stop is worth less than profit that will not, and the ratio assumes how likely yours is to stop.
Neither assumption is shown. Both were made about an average of other businesses, not about yours. That is why two businesses with the same inputs produce the same output and sell for different prices.
What to verify before paying
- What the ratio is drawn from, in writing, before the first fee.
- Whether the data is completed transactions or listings, and the period it covers.
- Whether the tool distinguishes seller's discretionary earnings from EBITDA, and which of the two it uses.
- Whether businesses of your size are in the data, or whether the ratio was built on larger ones and applied downward.
- What the operator does with your figures, and whether you can delete them.
- Whether anyone stands behind the output.
Matching an intermediary's service to your deal is a separate question, covered in matching a broker service. If the figure sits beside a listing, judge the listing service on its own; a buyer's checklist is the place to start.
Entering a flattering earnings figure feels sensible at the time, and seller preparation mistakes often look the same. A figure used to set an asking price is being used past any calculator's design, because the buyer's diligence builds its offer from your record, which the calculator never saw.
