Valuing Your Business
If you’re selling your business, one of the main challenges is what you think the business is worth and what the person on the other side of the bargaining table thinks it is worth, are usually two different figures.
Deciding on a market value
Regardless of the method anyone uses to value a business, it’s simply a matter of finding someone who will pay what you’re asking. Theoretically if no-one wants your business then it’s worth nothing (apart from the second-hand sale of any assets or inventory).
Past cash flow, profitability, and asset values are the starting points but it’s often the hard-to-measure factors such as key business relationships, reliable suppliers, loyal customers and goodwill that provide the most value.
To assist in this process, it’s usual to arrange a business valuation with a business broker, accountant or valuation expert with experience in your industry.
Factors influencing value
The reasons for selling a business can affect its value. For example, if you are forced to sell for health reasons, you may have to accept the first offer that comes along, which weakens your bargaining power and could drive down the value.
A business that owns property, machinery, raw materials, furnishings, computer equipment or stock-in-hand has tangible assets that will have some resale value. This makes the business easier to value as you can often find current market value or at least replacement value if you had to buy everything again.
Many businesses have intangible assets with significant value. Some examples are a well-respected brand, positive customer word of mouth, and even the potential for growth in your industry could be viewed as an asset. These intangibles can be harder to value.
If your business owns the rights to patents, copyrights or well-established trademarks, these may add value to the purchase price of a business. For example, if you’re selling a patented invention, you may be able to value your business higher than a similar business selling an unprotected product.
Length of time
The longer your business has been operating, the more likely it will have a proven track record and cash flow, and possibly loyal customers who provide repeat business.
If you’ve only been operating for a short time, buyers may skeptical why you’re selling so soon.
If your business holds a license or distributorship rights for a product or service, the business could be worth more than a business that does not.
If your key employees are going to stay after the sale, the business may be worth more. Any written agreements or incentives to retain key employees could add value.
Remember, the true value of a business is always what someone is willing to pay for it. To arrive at this figure, buyers use various valuation methods, often to give a sense of reassurance that they are not paying too much. The main methods are as follows:
Add up the assets of a business, subtract the liabilities, and you have an asset valuation – nice and simple. So if your business has $500,000 in machinery and equipment, and owes $50,000 on equipment finance, the asset value of the business is $450,000.
A buyer could decide to just buy the assets of a business rather than take over the business as a going concern. Consider:
- Property or other fixed assets that may have changed in value. Just because an asset is ‘valued’ at a cost on the balance sheet, doesn’t mean that’s what you should sell it for.
- Assets that you’ve added value to, for example that have been installed, or improved. These may be worth more than just book value.
Entry cost valuation
An entry cost valuation reflects what it would cost someone to start the business from scratch, as it’s always an option for them. To make an entry cost valuation, calculate the cost of:
- Purchasing or financing assets and developing the products or services.
- Recruiting and training employees.
- Building up a customer base and generating repeat business.
- Knowledge of networks, suppliers, competitors and processes.
Industry rules of thumb
In some industry sectors, buying and selling businesses is common. This has led to industry-wide rules of thumb that are typically considered in valuing the business. These rules of thumb are dependent on factors other than profit. For example:
- Turnover for a computer maintenance business or monthly recurring revenue for a subscription business.
- Number of customers for a mobile phone airtime provider.
- Number of outlets for a real estate agency business.
- Net profit multiplied by an industry standard number.
Buyers will work out what the business is worth to them especially if they can merge your customer base with their existing business.
How you value your business comes down to what kind of business it is, how many employees you have, and your ratio of asset to debt. It’s important to get professional advice when valuing your business, as a broker or accountant will know exactly what method suits your business best and will be able to pinpoint any liabilities that could affect the valuation.
Note that the resources listed here are meant solely as overviews and helpful information. Please consult experts regarding your specific security needs for your business.