How Much is My Business Worth?

If you are considering selling your small business, it will be important for you to evaluate your business in order to derive a reasonable asking price. Experts recommend that you assess the business from more than one angle in order to obtain an accurate picture of how much your business is worth.

Rules of Thumb Methodology

Begin by analyzing the history of your business to determine how much profit the business has been earning in excess of your own salary and benefits. Project future data based on your specific history, as well as general market trends to establish if the past is a fair representation of the future. This is typically known as “Rules of Thumb” methodology.

Market and Industry Trends

In examining trends, it is necessary to consider such items as supplier price changes, competition, and how the particular industry is performing. Also, take a look at prices paid recently for comparable companies in similar locations. Additionally, compare your company’s year-end gross profit and operating income to other industry competitors. If your company is closer to the top of the range in profitability, you can command a higher price for your business.

Owner Benefits

Then investigate the value of your business by using the Multiple Method; a pre-determined multiple (usually between 1 and 3) multiplied by the earnings of the business. The earnings or “Owner Benefits” amount can typically be used as an effective basis. This number is the total funds that you can foresee being available from the business based on past experience. The value is derived by adding the owner’s salary and benefits to the business’s profits; then adding back non-cash expenses.

The multiple that is used is mainly based on the industry. It is usually one time the value calculated if the business owner is the entire business, such as consulting or freelance services. Businesses with a solid customer base and more than 3 years in business most likely will be worth 3 times the basis.

ROI

Another calculation that should be looked at is the Return on Investment (ROI) that a buyer could expect to receive if they purchase your business. This is calculated simply as Gain from Investment minus Cost of Investment divided by Cost of Investment.

Assets

In addition, take into consideration the value of the business’ assets. This includes inventory and equipment.

Overall, it is important to keep accurate financial records. Buyers seeking financing to purchase your business will need to present information to back up the price being paid for the business.

How Much is Your Business Worth?

There are 3 basic approaches to value your business: the Asset Approach, the Income Approach and the Market Approach.

The Asset Approach is based on the principle of substitution. Meaning, it assumes that no prudent buyer / investor would pay more for a particular business than the cost to reproduce it right across the street. The main flaw with the Asset Approach is that it does not do a good job of capturing intangible value (goodwill). How you (and your employees) treat your customers and the reputation you hold in the marketplace is not something easily duplicated (and therefore valued with the Asset Approach). So, beware of the limitations of this approach. Understand that although an Asset Approach provides a relative indication of value for highly asset intensive companies, it may serve merely as a liquidation value for your service oriented company. The Income Approach and Market Approach do a much better job of fairly capturing the value of your company’s goodwill or intangible value.

The Income Approach operates under the assumption that a buyer will pay for the cash flow that your business is set up to produce going forward as of the date of sale. Buyers buy cash flow. How much they are willing to pay for access to your cash flow depends on the risk associated with the buyer actually receiving it once you exit the business. If your company shows a consistent history of steady cash flow and/or growth a buyer is likely to pay more for your cash flow stream (less risk) than for the cash flow stream of a similar company with unstable cash that cannot reasonably be assumed to reoccur in future periods (more risk).

By valuing the cash flow of your company you are inherently valuing EVERYTHING that your company does. If your company did something different (made different decisions or operated under a different philosophy) your cash flow would look different and the value of your business would be different. Your cash flow reflects all the decisions you make within your company. So, I challenge you with this question, if the decisions you are making don’t increase your cash flow (and buyers will pay you only for your cash flow) why are you engaging in those activities that don’t result in increased cash flow? They are not adding value to your company.

The third approach to value is the Market Approach. If you own a home or have rented an apartment, you’ve done a form of the Market Approach. When you compare and contrast similar properties and then use the comparative data to value your property, you are doing a Market Approach. In residential real estate you may compare things like price/sq.ft. or price/bedroom and price/bathroom. Once you obtain these ratios from similar properties you multiply the ratio by the square footage, the number of bathrooms, or the number of bedrooms in your home to get to a value for your property.

You can do the same thing with businesses. However, as you may have guessed, the value of your business is not driven by its square footage and its bathrooms. It is driven by other metrics such as revenue, assets, growth, leverage, turnover, liquidity, etc. Publicly traded companies and transactions involving other private industry participants provide an understanding of how price relates to the various financial metrics of these companies. Then, just like we did in valuing your property, we apply these market ratios to the metrics of your business to determine its market value.

Valuation is a complex matter with many intricacies that are not discussed here. The purpose of this article is to familiarize you with the basic valuation approaches employed. I don’t recommend that you attempt to value your business without the help of a qualified expert. But, I do encourage you to gain an understanding of these approaches so you can better focus on building value within your business before it is time to sell.

Selling My Business – How Much is My Business Worth?

Almost all businesses are for sale to some degree. Lets say yours is not For Sale. Assume Your business is worth $100,000. You love what you are doing, someone contacts you with an offer to buy your business for $500,000. Is your business now For Sale? The preceding is not a likely scenario for most business owners. To successfully sell your business planning and preparation is needed. But if you are now or at some point considering the sale of it you may want to consider the following 3 points:

1. Identify your honest interest level when selling your business. Early in the decision process of selling your business consider what approach you may take towards selling it. As a Business Broker in Florida I interact with the various interest levels by small business owners.

  • – My business is not for sale but if someone walks in and offers me way more than what I think it is worth- I would sell it
  • – My business is not for sale but if you run across someone that would want to buy it please let me know. – I want to pursue selling my business but I won’t sell it for less than…( A somewhat inflated price). I am willing to accept that it may take 1-2 years to sell my business, and if priced too high I can accept the fact that my business may not even be sold.
  • – I want to pursue selling my business and after significant due diligence I feel the price I am seeking is consistent to what other like businesses have recently sold for.
  • – I want to sell my business and I want out now. I will set my price aggressively and set a lower price than price currently sought for businesses similar to mine. I will expect this aggressive pricing to both help me sell my business and decrease the amount of time it will take to sell my business.

If you do have a true interest in selling your business as suggested in above last 2 points you do need to exercise due diligence to gain understanding of what the value of your business may be.

2. You can expect that the perceived value of your business to you and the value of the business to a potential buyer will probably be 2 different values.

  • – Ultimately the price of your business is what a willing and able buyer is prepared to pay to buy your business.
  • – Seek “reasonableness” to your price that you will seek to sell your business for. If similar businesses to yours are sold at 1 1/2 times adjusted cash flow, why is yours worth 3 times adjusted cash flow? – Ask yourself what you honestly would pay to buy your business
  • – Do a free Search on my website or other similar websites to find out what similar businesses to yours is asking to sell their business for. Remember – all businesses are different, but use such a search as part of your due diligence. A business for sale asking price and the price a business sold for can be greatly different, but asking prices can provide some basis-while current Businesses Sold information is more pertinent
  • – Speak to your trusted advisers. A business broker may be able to help with non-public info on sold businesses in your area. Your accountant or attorney also may or may not be aware of such sales as well. A Professional Business Valuation specialist may benefit you.

3. Whether it is part of your exit strategy to sell your business or not, you should have an exit strategy.

  • – Most small business owners do not have an exit strategy.
  • – If you own a business you should have an exit strategy. Do some planning, perform some due diligence. Know what you have or may have.
  • – Even if you are not planning to sell your business there is value in knowing approximate value of this potentially large asset. You know what your house is worth, you car, your other assets. Understanding the value of your business can be a significant piece of information when planning ahead.

Selling ones business can be a rewarding experience when done properly. Understanding a proper value for your business can set the stage to a successful sale of your business or a business that is unable to find a willing and able buyer.