As a business owner, there’s a high likelihood your business is your most important financial asset. Even so, if you’re like most business owners, chances are you don’t know what your business is worth.
The fair market value of your business won’t be found in your financial statements or tax returns. You won’t get the answer from your accountant or attorney. And the sale prices of similar business transactions can be hard to find, as sales agreements are usually kept private.
You can find the fair market value of public businesses on the stock market, but that’s not the case for a private business. While public company valuations can provide some context, it’s hard to translate that data to a small, privately held business…even when you take into account the difference in size, stability, liquidity, and other factors.
So how do you determine the value of your business? This is where a business valuation comes into play.
What Is a Business Valuation?
In short, a business valuation is the process of determining the value of a business. During this process, all aspects of the business are evaluated in order to determine its overall worth.
However, it’s not as simple as it sounds. Business valuations are complex, subjective, and highly dependent on relatively abstract factors like location and anticipated earnings. They involve a fine-tooth assessment of cash flow, projected growth, and internal and external risk factors that help determine the fair market value of your business.
Ultimately, a business is like any commodity: it’s worth what a buyer will pay for it.
If a buyer has a strategic reason to acquire a business, the sky could be the limit as far as value goes. If not, the value of your business may look very different. Having a professional evaluation of your business’ value is crucial to a successful sale.
At OIB, we help you determine a price that is both fair to you and attractive to a buyer, based on our extensive knowledge of the market.
We have a built-in advantage over most other appraisal firms: we’re engaged in the market of selling and buying businesses every day. We know what businesses sell for, because that’s what we do, day in and day out. Our valuation is more than an opinion: it’s supported by data from the sale of thousands of businesses, as well as from databases providing statistics from business sales across the country.
Why Would Your Business Need a Professional Valuation?
While the most obvious time to appraise a business is when it’s about to be sold, business appraisals are valuable in any number of situations, including:
- Buy/sell agreements
- Estate planning
- Stockholder disputes
- Tax disputes
- Business expansions
- Changes in partnership
- Divorce settlements or other personal life changes
…and many more. But you don’t have to wait for one of these events to happen to have your business evaluated. Just as you should always keep your business plan up to date, it’s ideal to always have an updated valuation of your business so you’re prepared in case an event arises where you need it.
How Are Business Valuations Calculated?
There are four main types of valuation most business appraisers use: Liquidation or Other Assets-Based methods, Investment Value/Capitalized Earnings, Excess Earnings, and Discounted Cash Flow/Future Earnings.
- The Liquidation or Other Assets-Based analysis estimates the resale value of hard assets, then subtracts business debts to reach an asset-based value. This method assumes the business will cease to exist and all assets will be sold to pay off liabilities. Liquidation is best used for businesses that aren’t making money and whose tangible assets are worth more than the value of the business (based on earnings).
- With the Investment Value or Capitalized Earnings method, you would first determine earnings over the next 12 months, then determine the desired rate of return, based on risk. Risk is calculated based on a comparison of alternatives (bank, securities, etc) and the rate of capitalization. This method is useful for businesses that aren’t making money and whose value based on earnings exceeds the value of their tangible assets.
- Using the Excess Earnings method, you would first determine the value of tangible assets, the cost of owning the business, and the value of earnings. You would then subtract the cost from the earnings to determine excess earnings. From there, you’d apply the rate of capitalization to the excess earnings. Finally, you would add the capitalized excess earnings to the tangible assets to determine the value of the business.
- The Discounted Cash Flow (DCF) or Future Earnings method attempts to estimate future cash flows, and uses that to determine a business’ current value. However, this method is rarely used in the sale of a small business.
Ultimately, the most reliable indicator of your business’ value is what a buyer will pay for it. Buyers decide what they’re willing to pay for a business based on how much they think the company will make them.
This means you need to be prepared to represent your business with well-presented documentation, an investment thesis, and knowledge surrounding how to counter price-chipping (a common strategy buyers use to lower the sale price by identifying possible issues with your business).
At the end of the day, evaluating a business is a complex process. Even if you follow every guideline and piece of advice you can find, there are assets or issues you’re going to miss.
That’s why the best course of action is to call in a professional like Opportunities in Business. With our experience, specialized knowledge, and tools, we can give you the most accurate estimate of your business’s worth. Plus, as business brokers, we can help you find the buyers you need and guide you through a successful sale.
Contact the team at OIB today to get started on your business valuation.