By: Curtis Kroeker
How much is your company worth? Valuation tools based on your own analysis and comparables are helpful, but here are some other tips for arriving at the right price.
When selling a business, it’s critical to get the asking price right. Set it too high and you won’t get any buyer interest. Set it too low and you’ll leave money on the table. So when you set a price for your company make sure that every penny of company value has been accounted for while also remaining realistic.
Unfortunately, setting the right asking price for your business is not easy. To determine a price that is fair to you while still enticing potential buyers, most sellers will want to leverage the expertise of a professional appraiser or business broker. In advance of doing so, however, there are several steps that will help you prepare documentation to help in the appraisal process and formulate a ballpark estimate of your own:
1. Estimate the liquidation value of your business by assessing the value of its tangible assets.
This works best for more capital-intensive businesses, but is a useful exercise for most small businesses. To start, make a list of all of your business’s physical assets including furnishings, fixtures, equipment, and inventory. Then consider their acquisition cost, use, age and condition to estimate a realistic value. The summation of these values is one measure of the value of your business. For most businesses, this will fall short of the actual value as this approach doesn’t take into account cash flow, intangibles, and other factors. However, it’s a useful data point as you seek to understand the value of your business.
Tip: At the end of the valuation process, compare the business valuation derived from other valuation methodologies to the total value of all tangible assets. If the value of the assets is close to the appropriate asking price for your business, asset sale/liquidation may be a more expedient and cost-effective way to recover value and exit your business.
2. Estimate the value of your business using an earnings multiple.
Multiples are ratios of business value to key financial indicators, usually revenue and cash flow. Multiples vary according to business type, geography, and a wide host of other factors. As a result, business values typically range from one and four times annual cash flow. When evaluating multiple ranges, consider key questions such as:
• Does your business have positive revenue and profit trends?
• Does your business feature exclusive products or territory? Is it prohibitive for entrepreneurs to start similar businesses from scratch?
• Do your business benefit from recurring revenue from established customers?
• Does your business have a proven brand, a respected reputation or a leadership position in its industry?
Answering “yes” to one or more of these questions likely justifies using a multiple at the higher end of the spectrum.
Tip: Business-for-sale sites such BizBuySell.com offer inexpensive, easy-to-use tools that enable you to query a database of past small business sales to arrive at a set of businesses comparable to yours. By looking at such comparables and their selling price multiples and answering questions such as those listed above, you can start to hone in on a multiple range and, thus, a potential valuation range for your business.
3. Assemble the necessary financial statements to enable an income-based valuation.
Organize your financials:
Strong business valuations begin with the assembly of formal financial documents for the current year as well as the previous three years. Depending on your bandwidth and accounting skills, you may need a bookkeeper to help you prepare the following essential statements:
Income statement detailing gross revenue, expenses and bottom line profits (or losses)
Cash flow statement showing how money moved in and out of your business, and how business assets changed as a result
Balance sheet showing the value of all tangible assets and liabilities
Prepare a statement of seller’s discretionary earnings:
Work with your accountant or bookkeeper to recast your business income into a statement of owner’s cash flow or statement of seller’s discretionary earnings (SDE). While the income statement reflects the full range of normal and legal deductions, the SDE or owner’s cash flow statement presents the full earning power of your business after adding back one-time, non-recurring purchases and discretionary expenses not essential to business operations. It is this full earning power of your business that is, ultimately, of key concern to prospective buyers.
Identify key trends shown by the financial statements:
Analyze the picture painted by several years of financial statements to understand how your business is growing (or not) in terms of top-line revenue and bottom-line income and what that means for cash flow and seller’s discretionary earnings. These trends will have a significant impact on your ultimate asking price.
Conduct an income-based valuation:
Most experts agree that this is the best means of valuing a business. Unfortunately, it’s also rather complex. As a result, most business owners will want to employ a business broker or appraiser who will use the inputs outlined above to derive a business valuation range via this approach. However, by assembling the financial statements and looking at the financial trends you will be able to better understand, assess and be comfortable with the resulting valuation.
The value of the tangible assets of your business gives you an approximate “liquidation” value. Earnings and other valuation multiples give you a sense for the market and a ballpark estimate for the value of your business–both of which are helpful in making the decision to sell and building your comfort with that decision. At the end of the day, however, you will want to employ the income-based approach to really understand the value of your business to a prospective buyer. To do that, most sellers will want to employ the services of a professional appraiser or business broker. The fee charged by these professionals is money well-spent to ensure that you set the right price for your business. After all, if you don’t set the right price, you’ll either fail to attract buyers or leave money on the table.