Knowing what your business is worth is key to selling it at a profit. Your business valuation is also likely to be the first concern of potential buyers. So how do you properly determine the value of your business? The answer can be complex and somewhat confusing because business valuation is an art, not a science. Valuations are subject to the appraiser's judgment, skill, and quality of methodology. That considered, there are several basic principles that are always part of any business valuation.
Standards of ValueIn general, appraisers use several standards of value for businesses: • Fair market value — This is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell - both parties having reasonable knowledge of the relevant facts. It is essentially what a buyer would pay for your business in an open market.
- Intrinsic value — Stock values that investors would consider.
- Fair value — Legal standards to value.
- Investment value or strategic value — The value to specific buyers. This could exceed fair market value.
Approaches to Business ValuationThese values factor into all of the three of the most commonly used approaches to valuing a company:
- The asset approach — values the assets of your business minus the liabilities.
- The market approach — based on what other, similar businesses are currently selling for.
- The income approach — derives from the present value of the income stream your business would bring to an investor.
Multiple of Past EarningsNext, the appraiser will determine what multiple of your past earnings (typically a number from less than one to six) should be factored into the value of your business. This is based on the concept that your business is worth a multiple of your past earnings if a buyer can project those earnings will be maintained after the purchase. Higher multiples are given to companies that have excellent books, impressive growth, and demonstrated strong potential for future growth.
Owner's BenefitIn determining a multiple for smaller businesses, appraisers often use the owner's benefit equation. Owner's benefit equals the net income, plus depreciation, interest, and the owner's salary and fringe benefits. In other words, it represents all the income available to one owner if the company was debt free. EBITDA is used by larger businesses and includes normalized salary and benefit package for an executive to operate your business.
Business Valuation in a NutshellThere's no doubt that the process of business valuation is complex. Summing up the factors we covered, your business is essentially worth the following: • A multiple of earnings compared to like businesses (gross sales or owners benefit times an industry multiple).
- A capitalization of the net profit 20% to 50% or a simple multiple of owner benefit.
- And if your business makes little or no money, asset value is the only value. (Goodwill + Inventory + Equipment + etc.) Either sold as a whole or liquidated over time.