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 ‘!