What is My Business Worth?
As a Frequently Asked Question, "what is my business worth?" is pretty close to the top of the list. The usual answers are insufficient to give business owners a realistic picture. When people add what I'm about to share with you, they often say "of course..." but all the way up to that point, it's not uncommon to hear business owners say "impossible."
In the usual discussions about business valuation, analysts and advisors are quick to pick up their favorite tool.
One might love the market valuation method. We see this with residential real estate sales a lot and it's commonly referred to as a "Comps" approach. The advisor, agent, or analyst, goes into a database and looks for similar businesses that have sold recently. When abundant sales data exists, this can be useful, but it's not enough...
Others prefer the asset-based valuation method. In this method, we do some basic math. Total assets - total liabilities of a going concern (a business that will continue operating) - or - the value of liquidation of assets. In other words, what the assets owned by a business might fetch under current market conditions.
The discounted cash flow (DCF) method is one of the most common methods used - particularly among the investment banker crowd. This method involves applying a discount rate to account for the cost of capital over time, a growth rate, an EBITA or earnings multiple, and a tax rate - all applied over a period of time. This often looks both backwards at historical data and forward into a forecast period.
There is a simple multiples of earnings valuation method where analysts will reference an industry benchmark for the industry, performance, market cycle, etc. A multiple is then applied to earnings and a resulting value is derived.
A capitalization method attempts to find a rate for a given market and market cycle and apply that rate to the net operating income or NOI. Common in commercial real estate, Value = NOI / Capitalization rate.
In addition to the above and other methods, the source data used for calculations can range from financial statements, budget projections, tax statements, industry reports, comparable sales, even the published treasury rates. Knowing this much, it should be no surprise that valuations, offers, and discussions around what is my business worth can range broadly from buyer to buyer. Depending on which method they choose to use, results may vary.
At Transworld Business Advisors of Frederick, we offer a valuation service that shows value across 11 different valuation methodologies. For a fixed fee, we produce a 30-page report that gives business owners some idea of what their business is worth when viewed through multiple lenses. Be prepared and be informed. Order your report here.
Everything above is great to know, but it is still insufficient for answering the question What is My Business Worth? As we are about to see, one of the most important ingredients in the formula hasn't been discussed yet.
The Other Half of the Answer to What is My Business Worth
The other half of the formula includes the buyer. This is perhaps one of the most important variables in the What is My Business Worth discussion and it's also one of the most overlooked. The advisor, broker, agent, owner, banker who ignores this variable does so at their own risk. The math can be perfect across all valuation methodologies and we can assert a value until our mouth runs dry and our finger ache from typing, but the the real "Worth" of a business is only expressed when a willing seller and a willing buyer come together to make a market. It's at the nexus where agreement occurs when value is actually determined and expressed. Only when the ink is dry do we have our unarguable answer.
An Easy to Understand Example
To understand why the buyer is so important to the equation, we'll share a simple example. Imagine you want to sell your vehicle. You own a 1976 GMC Suburban Classic with a 1967, 327 Corvette engine, a 4" lift kit, hooker headers, 2" pipes, and a 96 can cooler rack mounted to the front. On the top is a rack of halogen lights, a trucker's air horn, and the entire thing is painted black with yellow and orange stripes. Windows are tinted black and the word "Mongo" is printed on a windscreen mounted to the front of the hood. This beast gets 11mpg on the open road and 4mpg in 4-wheel drive in the mud. You used it for a few years and are now ready to move on to a more conservative and fuel efficient vehicle to get you back and forth to work.
Five potential buyers present themselves:
- A 14-year old boy who thinks your truck is the coolest thing he's ever seen
- A college student who wants the biggest vehicle he can find to bounce around off road
- A collector who owns a restoration business and loves 1970's GMC products
- A snow plow company
- A junk yard owner who sells classic parts
Imagine how each of the above buyers might value your truck. No matter what valuation method you use or what you offer it for, each of the above buyers probably has a different idea of what they might be willing to pay. You're likely to get baseball cards or your lawn mowed by the 14-year-old boy (who can't drive it if they wanted to). A snow plow company might be willing to pay more than the college student because they see income potential. A collector may value something you don't even see in the vehicle. Make sense?
A Better Question
Instead of merely asking What is My Business Worth? a wise seller (or advisor) is going to ask "What is My Business Worth to Whom?" and then craft a strategy to not simply sell, but sell to the right buyer. The results of this approach can be profound.
Types of Business Buyers
There is a lot on the internet about different types of business buyers, but for your convenience and to highlight a type or two I don't find discussed, I'll summarize a few of them for you here.
The Non-Buyer Buyer
This is the category of buyer that gets left out of the discussion too often. Any business broker, agent, advisor, or for-sale-by-owner amateur will recognize this buyer type as a drain on resources. Sometimes, non-buyer buyers are referred to as "tire kickers." These are individuals that do not have the experience, the knowledge, or the financial resources to buy your business. They may talk a lot, ask a lot of questions, and even make offers, but they're not serious. Think about the 14-year-old in the above example. They think what you're selling is cool, but there is zero chance they're going to buy unless some wealthy backer wants to buy it for them.
Even if a wealthy financial partner wants to buy your business for the non buyer buyer, there is a danger that they're going to get hurt if you sell it to them. This can be argued, but I would content that if caveat emptor (let the buyer beware) is part of your philosophy and you'd be willing to sell your business to a non-buyer because they offer a price you like, I'd caution that deal can and do blow up after-the-fact. You're opening yourself up to an argument that you knowingly took advantage of someone. Words like fraud, contract rescission, remedies, and damages come to mind. These are best to avoid In this author's opinion.
Transworld Business Advisors of Frederick screens non-buyers from the buying process and can save countless hours for a business owner trying to sell their business.
The Strategic Buyer
in the above example, buyers #4 and #5 might be considered strategic buyers. One wants the asset to perform some kind of work they know will produce income - and therefore might be willing to pay a little more. The other wants to break up the asset to be used as components in other activities - and therefore might not be willing to pay for the good will or even full market value for the assets.
Another type of strategic buyer might be looking to penetrate or expand into a market. They may already be well established elsewhere and see your market as desirable.
The Private Equity or Portfolio Buyer
Another type of buyer is the private equity or portfolio buyer, or one who needs a particular type of business (or positive / negative cash flow) to offset other elements within a portfolio. Believe it or not, I've known buyers who will absolutely buy a non-performing property or business because they need the losses to offset gains realized elsewhere in their portfolio.
The Individual Buyer
Individuals buy businesses for all kinds of reasons. Some want out of the 9-5 grind. Some want additional revenue streams. Some simply want to realize their dream. Some are working together as a group and hoping to replace an ownership / management team already in place.
Employees can buy as individuals making offers or as part of an employee stock ownership plan or ESOP. There are even third parties who specialize in providing leverage to employee groups who wish to buy a business and convert to an ESOP.
Employment Based Immigration (Visa) Buyers
Whether through an EB-5 or an EB-2 visa program, employment based immigration buyers are dually motivated by the prospect of immigration into the United States and the opportunity to forge a good living within the structure that our country's laws allow.
What to Do With Buyers
In the context of determining an answer to the question What is My Business Worth, listening carefully to buyers tops the list of things to do with buyers. Every buyer comes to the game with different capabilities, motivations, and strategies. Understanding the fact that different buying strategies exist, matching those strategies to the buyers who present themselves (or that you seek through targeted efforts), and understanding how the business you're trying to sell may be valued by each different type of buyer is important.
After the standard non-disclosures are signed, getting to know buyer motivation, means, and mechanisms should be the focus. This can be done by phone, by survey, or in person, but whatever method is used, write them down. Try to gain an understanding of what will be done with the business after the sale. A lot of times, this will give clues to how a given buyer values the business.
I recently learned from one of my clients that their landlord sold the property they were leasing to a hedge fund. The property was offered for sale at $4MM. The business owners was given 2-days to buy it before it was locked up under contract by the hedge fund. The business owner was unable to secure the necessary financing, etc to get a deal like that closed in two days, but she tracked the situation as it unfolded. After the sale, the hedge fund re-sold that piece of property for a different use for $14MM. That represented a $10MM gain for the hedge fund.
To the business owner, the property was worth $4MM. To the hedge fund, that same property was worth $14MM. Might there have been an opportunity for the property seller to sell that property to the hedge fund for more than $4MM?? The possibility exists, but we'll never know at this point. The market was made first at $4MM, then again at $14MM a short time later - with zero change in the underlying material asset.
About Transworld Business Advisors of Frederick
Transworld Business Advisors of Frederick is an independently owned and operated member of the largest business advisory / brokerage firm in the world. With 40+ years of experience, 650+ brokers, 250+ offices in the United States and 18 countries, and an active buyers list of 365,000+ buyers, we offer the best chance for business owners to get their businesses sold. Our advisors bring the experience, tools, and skills to help business owners with sales, mergers and acquisitions, franchising, and valuations. Contact us today to get the help you need.