You have spent a lot of time building your business, but about three to five years ago you began to think about selling, so you have been taking all the necessary steps to position it for sale. Good for you.
Now that it’s time to actually pull the trigger, what kind of price can you get? What is it your business worth? The first bit of important advice is not to set the price yourself. You don’t have the objectivity, so work with a professional business appraiser. What follows is really advice about how to collaborate with your appraiser.
There are three basic approaches to determining the value of a business and lots of variations within those approaches. They are also not mutually exclusive. You and your appraiser can use some bits of all of them to come up with the right number.
Approach #1 – Assets Minus Liabilities
Of course, valuing the assets can be difficult too. If you are liquidating the business, the value of assets will be determined as if they were to be sold over a very short period, usually 12 months. If you are selling the business as a going concern, the time frame can be longer. Don’t forget liquid assets such as cash in accounts, current accounts receivable and personal property bought through the business like a car. If you plan on taking some or all of the liquid assets with you on the sale, then they would not be included in the valuation.
The asset approach is not appropriate for all kinds of businesses. If your business is hugely profitable but owns nothing more than a computer and a file cabinet, then it’s time to try some other methods.
Approach #2 – Look at the Earnings Value
This approach looks at the sum of pretax earnings, owner’s salary, interest expense, depreciation and any personal expenses. There are a number of variations on this approach that add or subtract various different items. That sum, whatever it ultimately includes, is then multiplied by a factor between 0 and 3 to predict future performance. The secret’s in the factor, of course. For small businesses the magic number usually comes in somewhere between 1.5 and 2.5.
If this approach yields a number lower than the asset approach, go back to Approach #1 or on to Approach #3.
Approach #3 – Sales of Similar Businesses
Your buyer will certainly be aware of the recent sales prices of similar businesses. Of course, no two businesses are identical, so the conversation will be about distinctions, which you should be prepared to discuss on the basis of the analyses you have done under the first two approaches.
Setting the right price for your business is essentially a middle step in a process that begins years before the sale, when you begin to position it for the best price and ends when negotiations with your buyer are concluded and the deal closes. To get the most out of a venture that you have put so much into, it is important to understand and anticipate as much of the process as possible.