Placing a concrete value on your business is a difficult task
Not just because it’s potentially complicated, involving a host of both tangible and intangible variables, but also because it’s an emotional situation as well. Your business is your baby. Unless you’re a serial entrepreneur or a shark investor who buys and sells businesses all the time, you’ve likely invested years of your life – and a significant part of your soul – into this enterprise. While the idea of selling it may be exciting and feel right, it’s not easy.
And that’s why so many business sales fail: far too many business owners completely overvalue their companies, pricing right out of the running for investors and buyers who are hoping to profit from the purchase and/or continue running the business profitably going forward. So, to answer the initial question this article poses – your business may be worth less than your emotions want to believe.
But, if you can put those feelings aside, it is possible to come to a reasonable valuation of your business, and to optimize that value further as you prepare to sell, so you’re sure to get the most possible for the company you’ve worked so hard to build.
The most common valuation methods
Valuing a business is a complicated task, and the most complex the business itself is, the more involved that task becomes. Because there are so many variables involved in the different types and sizes of companies across all different industries, there is no simple one-size-fits-all formula for placing a value on business.
There are several accepted methods for doing so, and professional business brokers and accountants experienced in valuation will usually use a combination of two or more of these methods to accommodate the idiosyncrasies of each company. So, while the following brief explanation should help offer a surface understanding of business valuation, it’s strongly recommended that you consult with an experienced professional before arriving at a value on your own.
- Multiple of Earnings – One fairly straightforward method of placing a value on your business is to apply an established industry benchmark ratio to your annual profits from the last few years. The ratio may fluctuate over time because it is based on how the industry is growing in aggregate. This is a commonly used method because projected earnings are a key factor interesting a buyer. However, it can be misleading if an abnormally large contract was won in the recent past, or if a major loss occurred during the current year and is not reflected in the numbers being used.
- Asset-based Value – For businesses currently in liquidation or for some other reason not currently running at full capacity, a simple assets-minus-liabilities computation can arrive at the currently saleable value of all the company owns. In some cases, this is the best option, especially if the buyer is a competitor hoping to expand by absorbing facilities, equipment, or supplies. However, many assets of an established business are difficult to effectively place a price tag on, such as reputation, brand equity, and customer loyalty.
- Entry Valuation – This method bypasses many of the unique aspects of the particular business by trying to determine how much it would cost for the buyer to start an identical business from scratch and using that as a starting point. Of course, this method will be combined with at least one other method to account for the less tangible assets mentioned above.
- Discounted Cash Flow – This formulaic method is often used by investors investigating the value of a stock offering as well. It involves reviewing past cash flow and extrapolating that out over the next 3-5 years with a discount applied based on the inherent risk in the industry and the business itself. While the actual calculations can be complicated, this method tends to be a favorite for many professionals because it provides a relatively consistent level of accuracy across industries.
- Rule of Thumb – Whether it be a solid combination of two or more of the above methods or a slight variation on one of these themes, some industries have their “rule of thumb” methods for valuation. For instance, the retail industry tends to use the Multiple of Earnings methodology, but using turnover rather than straight earnings because it is a better indicator of future revenue and ROI than the earnings figure would be.
Again, your particular business and the state it’s in will determine the most appropriate valuation method, as each have their strengths and weaknesses. Your prospective buyers are going to be looking for reliable documentation of any value estimate you provide and will be making a decision based to a large extent on how much faith they put in that valuation. So it’s in everyone’s best interests to make this an honest, defensible estimate.
That being said, the business sales process can take upwards of nine months to over a year, during which time a wise business owner will take steps to increase real and perceived value in demonstrable ways to make the sale more and more attractive to buyers.