You may have spent years of hard work building up your small business – sometimes even passing it down from generation to generation before finally deciding to make a sale. You know every intimate detail about running the business, and to you it is an invaluable part of your life. How do you set a logical value when it is time to sell that will provide you with the return that you need and still attract a solid buyer? Annual revenue is not the only indicator of value, and indeed may only be a small part of the picture. Perhaps the most challenging part of small business valuation is realizing that your personal feelings about the business have no meaning in the process – and in fact, they can adulterate your business logic unless you are very diligent.
Main Valuation Methods There is no one right answer to business valuation as there are any number of ways to assign value to the business and the assets contained within. There are, however, a discrete number of valuation models that are utilized throughout the business world and choosing one (or more) of these methods allows you to clearly communicate the value to potential buyers.
Historical Earnings / Earnings Multiplier The current value of your business is determined by a variety of factors including gross income, capitalization of earnings, and the ability to repay debt. If your business is able to repay debt quickly and maintains a positive cash flow, then the business value rises; conversely, a business that can only bring in enough income to pay bills through great effort will have a lesser valuation. All of these factors go into deciding a number for a historical earnings valuation. The similar earnings multiplier method is also based on earnings, but utilizes an agreed-upon multiple of the business’s earnings potential.
Asset Valuation Perhaps the simplest method is looking at the book value of current tangible and intangible assets. This would include all real estate, inventory, equipment, cash, options, trademarks, customer relationships and patents. Pulling these different pieces together and assessing their value provides the basis of your asset valuation. Keep in mind that customer good will can be a solid asset, as well as any recent R&D that has promise – these are the assets that are often overlooked when small business owners consider an asset valuation.
Relative Valuation If you have a standard type of business such as a restaurant, food truck or real estate agency, there are likely several other businesses in your area that have been sold recently. Use the sales of these businesses as a basis for comparison, making adjustments for differences as you go. If you have a non-standard type of business, you may need to look further afield to find a comparable business and make a reasonable valuation.
Discount Cash Flow Valuation While not used as often as the other valuation methods due to its relative complexity, this method offers a valid answer if profits are not expected to be stable in the future. This could be due to either R&D in progress that is projected to greatly expand the organization or a gradual revenue decline due to market maturity. Take your business projections for the next several years and discount them back to present day value to determine an accurate valuation for your business.
Choosing the Right Method Asset-based valuations are the most appealing to many small business owners due to their simplicity, but there is a potential to undervalue the business as future earnings are not always taken into account. This type of valuation is most often used for liquidations or defunct businesses, and not as often for active and thriving companies. Earnings evaluation methods such as the earnings multiplier or historical earnings methods are often utilized when the buyer wants to compare value across businesses in different locations or industries. Multiplier methods can be challenging as they require the buyer and seller to agree on the multiplier, which can be a factor of the business environment yet also needs to consider socio-economic factors.
Comparing the results of two or more methods of valuation can give you the most complete picture of your company, as well as provide significant due diligence that can be passed along in discrete chunks to prospective buyers. This is much like selling a used car – you want to have full disclosure (in most cases!), while still presenting your business in the best possible light.
Completing the Valuations, you are working through the various business valuation processes (see more you will undoubtedly find ways that you can quickly and easily improve your business’s overall value. If you are not happy with the valuation that you come up with, the good news is that you can still make changes, although planning is critical as some changes may still take months to execute. Realistically speaking, anything that you can do to improve the future earnings potential of the business will have an impact, and documenting your past business successes is one of the key ways that you prove solid value.
Take the time to identify future opportunities for an incoming owner, giving them the value of your insight. Maybe there are specific parts of the business that you always wanted to improve and never had the time or the infusion of capital to do so – now is when you can document details and pass them along for consideration.
All of this mental energy and upfront work adds value to your business, as it gives potential buyers the feeling that they can pick up the ropes and have an immediate roadmap to get started on or tweak. Organization is another key strategy to consider in the months leading up to your sale. No one wants to come into a messy business, and having your financial ducks in a row makes the business that much more attractive to potential buyers.
The same goes for the physical location (if applicable) – get inventory levels up to date, take care of any problem employees, and handle any maintenance issues that you have been putting off. While small, these are the cosmetic changes that can make the difference between breaking even on your sale and gaining a tidy sum to start on your next venture.