When it comes to business valuation, there are a lot of myths and half-truths floating on the Internet. There are online calculators that let you calculate the value of your business for free, and business appraisers that might charge as much as $10,000 to $40,000 to perform a business valuation. How much should you pay for a business valuation? How do business valuations work? More importantly, what are the myths and common misconceptions when it comes to business valuations?

Misconception #1: Companies sell on multiples of gross revenues. It would be really easy to value a business if all you do is to multiply your annual revenues by a set multiple. For instance, if your annual revenues were $1 million and you learn that the magic multiple to use is 3, you just multiply $1 million by 3 and arrive at the business value of $3 million. Unfortunately, business valuation is not that simple. Let’s consider the standpoint of a business buyer. Suppose that your business that has annual revenues of $1 million produces $150,000 a year in profits. If the buyer were to buy your business for $3 million, the buyer might put 25% down and get a loan for 75% of the purchase price, or $2.25 million. A loan on $2.25 million at an interest rate of 5% amortized over 10 years equates to monthly payments of $23,864.74, which is $286,376.88 annually. As you can see, all the company’s profits of $150,000 a year is nowhere close to covering the mortgage payment, so the purchase price does not make sense to the business buyer. As tempting as it is to believe this myth, most privately held businesses do not sell based on a multiple of their gross revenues.

Misconception #2: Google (or some other large company in your industry) will pay a ridiculous amount of money for your business. This is a half-truth. It is true that in the high-tech industry in particular, companies such as Google and Microsoft have paid a lot of money for certain strategic purchases. These acquisitions get a lot of media attention partly due to the fact that the purchase price can be many times the gross revenues. Keep in mind, however, that to a strategic buyer, the most important factor in determining the business value is often times not the subject company’s gross revenues. When Google purchased YouTube, Google was acquiring the audience of YouTube. The fact that YouTube was not profitable at the time had little consequence to the purchase price Google was willing to pay ($1.65 billion in stocks, by the way). Will your company be acquired for strategic reasons that have little to do with your current financial performance? It depends on who you are, but most business owners should not count on it.

Misconception #3: Your business value will be dramatically decreased by a low bottom line. This is another half-truth. In the world of small business purchases, buyers understand that business owners frequently try to minimize their bottom line in order to minimize their tax obligations. In order to accurately value a business, the business owner needs to perform a recasting of the company financials so that certain expenses shown on the profit and loss statement are added back to the net operating income. The resulting number is known as the Owner’s Discretionary Income, or ODI. In other instances, EBITDA is used although adjustments are sometimes necessary to reflect the true EBITDA of the company. Don’t be discouraged if your company books show a low or even negative net income figure. An experienced advisor can help you recast your company financials to reflect the true earning power of your business, and present your company to potential buyers in a much more positive light.

Misconception #4: All business valuations are created equal.The fact that there are many myths and half-truths about business valuations is a reflection that business valuation is not a simple process. There are guidelines that apply in certain situations but not others. There are online calculators that let you calculate your business value for free, but as the saying goes, people often get what they pay for. This is not to say that you need to spend as much as $10,000 to $40,000 for a certified, formal business appraisal. How much to spend on a business valuation depends on the size of the company and the purpose of the valuation. Chances are, your needs fall somewhere in between a do-it-yourself-for-free business valuation on one end, and a $40,000 certified business appraisal on the other end. Choose a business valuation service that focuses on serving companies similar to yours. If you are a small business owner, you probably don’t need to spend tens of thousands of dollars hiring a business appraiser who typically values large companies.

Advantage Business Valuations provides business valuation services for small to mid-sized business owners in the United States. Founded by Aaron Muller who has valued thousands of companies as a business broker, Advantage Business Valuations helps small to mid-sized business owners determine the value of their business with ease and confidence. To discover the value of your business, visit www.AdvantageBusinessValuations.com.