What is My Business Worth?

Small business owners all over the world usually fail to stop and ask themselves just what their business is worth until they are attempting to sell their business or preparing for retirement. However, gaining early perspective concerning the worth of your business from a third party can greatly benefit the future of your business goals and overall direction. If you are at the point of selling your business or planning for retirement, succession, or divorce, this simple question has no simple answer. Depending on what value is being calculated, a third party could conclude on a much different price when assessing fair market value versus another calculation like most probable selling price.

For the sake of simplification, only the most probable selling price method will be discussed here. Since you are probably hoping to determine the value of your company so you can sell it or pass it on to an heir, this is the method that will be determined. Three approaches can be taken, including market, income and asset approaches. Market approach is when your business is compared to similar businesses that sell the same goods or services and how much they were sold for. This cannot be the only approach however, as comparing businesses in different states that are different sizes from one another can throw off findings.

Income approach calculates how much money your business is generating for you on a yearly basis and determining a reasonable price it could be sold at. Since small businesses are a risk and not guaranteed to generate income, an accommodation must be made for the risk factor. Cash flow is identified through a process known as recasting which involves dissecting tax returns and determining how much money actually benefited the business owner. By following trends of past years, you can calculate estimated future returns the business will make for the new owner.

The final approach is called asset approach. Also known as cost approach, this method deals with physical assets but does not provide much value for goodwill. Many businesses place a good amount of emphasis on goodwill, meaning this would not be the best approach. However, if your business has a number of investments in outside sources, this could be a very beneficial method of determining how much your business is worth. As you prepare to put your business up for sale, understand that negotiations will undoubtedly occur and the market will be the ultimate determining factor of what you can sell your business for.

How Much is My Business Worth If I Sold It?

Does a business owner know what his business is worth – we suspect he thinks what the firm is worth, but in fact does not know if that is what the market would call a ‘ fair ‘ price.

When a company is private and the business owner is contemplating selling there are essentially two methods that one focuses on:

1. The value of the hard assets

2. The value of the business as an ongoing concern

When we look at category #1 above the focus gets more specific. The owner should ask himself if the business were liquidated what would be the price of those assets. Asset valuators actually break that category down into two other areas – fair market value, forced value. By forced value we mean a third party usually coming in and selling assets immediately at best bid. As one can imagine that is never the optimal selling strategy!

When someone is considering buying a business they consider the ‘book value ‘of the assets – which is simply the value on the accounting books relative to any debt on those assets. That clearly is also not an optimal number for the owner, and even the buyer sometimes, as it focuses on accounting and deprecation issues, not the true value of the asset in today’s market.

Focusing on our item # 2- Going Concern – when a third party looks to purchase a business he views the asset in the context of using those assets to generate future profits.

This brings us into the main category in the Going concern valuation method, which is the earning capitalization. Buyers, ( and sellers obviously ) focus on looking at the earnings over the last number of years, placing a realistic value on those earnings, and then determining how many more times over that level of earnings the purchaser will pay.

Lets use a simple clean example – A company has earned 200,000$ net over the last 5 years. But 100,000 of that is owner’s salary. That 100,000 are deducted from earnings in the value calculation. So we are left with $ 100,000.00.

If a potential investor wants to earn an over all return of 10% on his money then he should be willing to pay 1 Million dollars for the business – the purchaser has ‘capitalized’ the investment at ten times the return.

Business owners should also know that each industry has its own capitalization rates, and the owner would do very well to investigate what capitalization rates firms in his industry are selling at. Naturally many of those numbers are smaller private deals that aren’t published, so the owner can do two things:

Research comparable public firms in his market space

Or

Used the services of a trusted third party advisor who knows his firms industry.

The general guidelines for determining the capitalization rate are:

– growth potential of the business

– the current economic environment

– the firms position in the marketplace

– overall financial structure and stability

– management

In summary, business owners should probably be investigating valuations of their business far before they actually entertain an offer. This will allow them to focus and negotiate with strength based on solid data typically used by third party purchasers – The Boy Scout motto works once again – ‘Be prepared ‘!

How Much is a Business Worth?

How Much Is a Business Worth? A Business Valuation Will Tell You

So you’ve finally found a business that interests you, it’s time for a business valuation. Remember a business is worth only whatever someone is willing to pay for it at a given point in time. At this point that someone is you!

Why Do I Need to Do My Own Business Valuation?

The business valuation is one of the most important steps in determining whether you buy this business or not. If the Seller’s broker or an outside source has created a valuation report, fine. Get a copy but don’t put a lot of credence in it us it as a guide line. You still need to do your own evaluation.

Remember, the Seller’s accountant has been trying to save the Seller from paying as small an amount of taxes as legally as possible. What shows on the bottom line for tax purposes, in most cases, are not the true earnings of the company. neither does the balance sheet show true market value of the company’s assets because he has been depreciating the business.

Ok, What Do I Need For A Business Valuation?

The following documents are critical for you to do your business valuation.

1. Profit and loss statements for three years, created by an accountant, not created on the seller’s computer.

2. Balance sheets for three years.

3. Federal Tax Returns (IRS) for three years.

4. Interim financials and balance sheets for the most recent reporting period.

5. Complete list of equipment, furniture and fixtures assigned market value.

6. Recent evaluation reports if any.

7. Appraisals on business assets.

8. Marketing and business plans including financial projections.

9. Brochures.

You have gathered all the information you will need to make a buying decision. You are now ready to…

Start Your Business Valuation of The Seller’s Business.

Remember, most businesses are managed in a manner to pay as little income tax as possible to the owner, not to see how much taxes they can pay. That’s why it is important to get a true financial report. You do not have to explain to the Seller why you are reconstructing the financials.

This is a very critical process to decide the worth of the business you are proposing to purchase. If you don’t feel comfortable, get some help.

Some Sellers will have already have done this, that’s okay, but you still want to do your own reconstruction. If the Seller presents you with a business valuation report with the financials reconstructed, watch out for overstated add backs or those items that can’t be verified. You only use numbers that can be verified from the financial information you have gathered yourself.

Things to Watch Out For

Sometimes, in an all cash business, the owner will not report all of his income. I do not listen to Sellers who want to add value to their business from unreported income. I tell them, too bad! The Seller either pays the piper up front or he pays when he sells. I figure if he will lie to Uncle Sam, he’ll lie to me. This should be a red flag.

This profit and loss reconstruction is the major factor in you determining the true worth of the business. You need to discuss each cash flow item with the Seller. You can do this in person or over the telephone. Don’t make a big deal out of this, but do get the information.

If the Seller asks why you need this information, tell him the truth. You are reconstructing his financial statements to show a true market value of his business. Many Sellers are hesitant to discuss some of the perks they have paid themselves. They probably have expensed items that were totally for personal use. These are the items you are trying to locate.

You will use this information only to justify the numbers you find through your reconstruction of the financial statements. You need to make the Seller feel comfortable in discussing these expense items. Assure him this kind of information stays with you and him only.

This process will help you determine the available dollars for you to service the debt, pay yourself or a manager, and give you a reasonable return on investment.

I know what you’re thinking…

This Sounds Complicated And I Need Help!

My book,Who Wants To Be the Boss?, has a whole chapter devoted to business valuation.

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