Opinion of Value
"What is my business worth?" This is typically the first question that owners ask us. When selling a business, it's critical to get the asking price right. Set it too high and you won't get any buyer interest. So when you set a price for your business, make sure that every penny of company value has been accounted for, while also remaining realistic.
Unfortunately, setting the right asking price for your business is not easy. To determine a price that is fair to you, while still enticing potential buyers, most sellers will want to leverage the expertise of a professional business broker. Business brokers will look at value in a number of different ways. Below are the 3 methods used most often to determine value.
1. Liquidation Value Using Tangible Assets
This works best for more capital-intensive businesses, but is a useful exercise for most small businesses. To start, make a list of all of your business's physical assets including furnishings, fixtures, equipment, and inventory. Their acquisition cost, use, age, and condition are considered to estimate a realistic value. The summation of these values is one measure of the value of your business. For most businesses, this will fall short of the actual value. This approach doesn't take into account cash flow, intangibles, and other factors. However, it's a useful number to have when seeking to understand value.
Tip: At the end of the valuation process, your business broker will compare the business valuation derived from other valuation methodologies to the total value of all tangible assets. If the value of the assets is close to the appropriate asking price for your business, then asset sale/liquidation may be a more expedient and cost-effective way to recover value and exit your business. A good business broker will discuss these options with you, and then you can decide which way to go makes most sense for you and your business.
2. Earnings Multiple Valuation
Multiples are ratios of business value to key financial numbers. Usually the numbers we are use revenue and cash flow in this method. Multiples vary according to business type, geography, and a wide host of other factors. As a result, business values typically range from one to four times their annual cash flow.
When evaluating multiple ranges, consider key questions such as:
- Does your business have positive revenue and profit trends?
- Does your business feature exclusive products or territory?
- Is it prohibitive for entrepreneurs to start similar businesses from scratch?
- Does your business benefit from recurring revenue from established customers?
- Does your business have a proven brand, a respected reputation or a leadership position in its industry?
Answering "yes" to one or more of these questions likely justifies using a multiple at the higher end of the spectrum.
Tip: A good business broker will also look at comparable businesses that have actually sold. Their selling price multiples will be a good indicator of market value and what buyers are willing to pay. After all, a business is only really worth what a buyer will pay for it.
3. Income-Based Valuation
Organize your financials:
Strong business valuations begin with the assembly of financial documents for the current year, as well as the previous three years. Organize the following documents and submit them to your business broker for analysis.
- Income statement detailing gross revenue, expenses and bottom line profits (or losses)
- Cash flow statement showing how money moved in and out of your business, and how business assets changed as a result
- Balance sheet showing the value of all tangible assets and liabilities
- Tax returns
Prepare a statement of seller's discretionary earnings:
Work with your business broker to recast your business income into a statement of owner's cash flow. While the income statement reflects the full range of normal and legal deductions, the owner's cash flow statement presents the full earning power of your business. Recasting consists of adding back one-time, non-recurring purchases and discretionary expenses not essential to business operations. It is this full earning power of your business that is, ultimately, of most importance to prospective buyers.
Identify key trends shown by the financial statements:
The picture painted by several years of financial statements will show how your business is growing (or not) in terms of top-line revenue and bottom-line income. Looking at cash flow and the owner benefit will have a significant impact on your ultimate asking price.
Conduct an income-based valuation:
Most experts agree that this is the best means of valuing a business. Unfortunately, it's also rather complex. However, your business broker will be able to help with this process. A good broker will go over the financial trends and the numbers with you, and show you how the resulting valuation was calculated.
How the valuation methods compare...
The value of the tangible assets of your business gives you an approximate "liquidation" value. Earnings and other valuation multiples give you a sense for the market and a ballpark estimate for the value of your business, both of which are helpful in making the decision to sell and building your comfort with that decision. At the end of the day, however, you will want to employ the income-based approach to really understand the value of your business to a prospective buyer. To do that, most sellers will want to employ the services of a professional business broker.
Not ready to sell your business yet?
Maybe you are planning to retire or moving out of the area, but aren't ready to sell your business just yet. That's OK! We can still help with giving you a free, no-obligation opinion of value. That way, when you are ready, you will have a good idea of what it's worth and where to start. We will be here to help when the time is right!