What’s the Right Number

We all like to think that a buyer for our business will see the deep intrinsic value, the hard work and long hours the owner and founder put into growing his or her business, but at the end of the day the price matters.

Many owners feel their business is worth far more than the market will handle: if you price it too high no one will bite. On the flip side – if you price it too low, you are shorting yourself monies due. Coming to the “right” valuation for your company takes some homework.

Here are some strategies to get to the correct valuation for your business when it’s time to sell:

Value of the Business’s Tangible Assets

For businesses with a lot of capital, this strategy proves most effective, but it can also work for smaller, less capitalized companies. Here’s the process:

  • Create a list of all physical assets – equipment, furniture, and inventory.
  • Analyze the condition, age, and the cost at acquisition, what did you pay for it?

This formula will be less than the actual value since it doesn’t take into account cash flow, reputation (that founding father in the community factor), and other important data. But it’s a start in the right direction.

When you’ve crunched the numbers, compare it to other valuation formulas. If the number is in a similar range, an asset liquidation or sale might be the best way to exit.

Earnings Multiple

Sounds complicated, but in fact it isn’t. Multiples are simply ratios of the business’s value to markers such as cash flow and revenue. The multiple will vary dependent on the type of business, industry, location, et al. In most cases the value is between 1 and 4 times that of cash flow.

What buyers will look at and you should too:

  • Are revenues and profits both trending upward?
  • Is your brand respected?
  • Does the business have any IP and/or exclusive products?
  • Do you have recurring or passive income?
  • Do you own your market? Are you the only provider?

If you can answer yes to most of these, it will justify using a higher multiple – i.e. a higher value.

Documentation and Details Matter. Financials will need to be prepared in order for an accurate valuation typically for the current and prior three years. Included should be:

  • Cash Flow Statements
  • Income Statement
  • Balance Sheet

Earnings Statement showing owner cash flow or discretionary earnings should be prepared by your accountant. This will show the business’s earning power – something potential buyers will hone in on immediately.

What’s Trending? The reason for pulling several years of financials is to view the trends and not focus in on spikes or dips in cash flow or revenue. Only by viewing the long term will a buyer be able to assess business growth which could significantly affect your final asking price.

In the end, most of us agree that performing an Income-Based Valuation is the best way to give a true value to your business – but it is also the most complex and time consuming. Working with a skilled professional to ensure it’s done correctly will make the buy/sell process a lot smoother – one with few surprises.