Looking at your business with an outsider’s perspective is difficult. Many business owners are overcome with emotion and believe their businesses are worth far more than the financial markets might indicate. In order to effectively sell your business, you must come to grips with the fact that selling a business is an emotionally-charged experience and you will only sell for the business fair market value a willing buyer is able to provide.
In determining your business’ fair market value, many variables are used both quantifiable and intangible. Of the many possibilities, the following are the most common ways to arrive at a likely range of selling prices
- multiple of earnings value, including and indication of the company’s “free cash flow”
- asset valuation including real estate, tangible and intangible assets
- comparison of value to other businesses of similar size in similar industries
Multiple of Earnings Value
Multiple of Earnings Value is one you may be somewhat familiar with as it tends to boil down to a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). This is a shorthand method of determining the cash flow available after operating the business to pay principal and interest, then provide a return to investors. EBITDA is determined as follows:
Net income after taxes
+ Interest Expense
+ Income Taxes
Additional discretionary expenses may be added back to this figure as well including excessive salary of the owner, wages of related family members who may not be necessary going forward, the cost of owning and operating cars, planes and boats run through the business, life and health insurance of the owner. The resulting “adjusted EBITDA” is a good approximation of the true cash flow available to the new owners.
Asset Value is a common approach used by conservative buyers. They are typically interested in paying a fair price based on the current fair market value of the assets employed in the business. Since you have owned and used these assets for many years, they have likely been depreciated on your balance sheet and the indicated value may not be the actual market or replacement value. You’ll have to work with an appraiser to come up with the current market value of these assets.
Whether or not real estate is included in the sale depends largely on the tax implications and personal financial strategies you employ. It may be to your advantage to sell the real estate outright along with the business or you may prefer to retain ownership and simply lease to the new buyer.
Furniture, Fixtures, Equipment & Inventory
These assets are valued in direct relation to the income they help generate. Their value is not based on their historical cost but rather by their function in helping to generate profits. A complete listing of all equipment, including office computers, copiers, etc. with current estimated values is a good place to start.
Goodwill & Other Intangible Assets
In many cases, intangible assets are of tremendous value while they are reflected at zero cost on the balance sheet. Items such as strong relationships with large customers, value of your brand, patents and copyrights, R&D and growth prospects all add up to competitive advantages and real value to you and your enterprise. Goodwill is the non-asset, profit-making infrastructure that you as owner have created while building your profitable enterprise. It’s the premium that is paid for a business, over and above the stated hard asset values. Nobody knows your business as well as you. So, if you ask yourself: “How much would I pay for this business?” the difference between price and indicated hard assets is goodwill.
A key aspect of the goodwill assessment is the buyer’s time horizon. A buyer will likely expect to recoup his investment in 5 to 7 years. If the goodwill calculation accommodates this timeframe, a deal can be structured. Another equally important aspect is terms. If you elect to participate in the upside of the business going forward through an earnout, a buyer will often be willing to pay more and share more of the future proceeds.
Every business is unique and it is impossible to identify one that is exactly like yours for purposes of comparison. However, you can track similar publicly traded companies and apply a discount for liquidity, size and risk as well as read about recent industry sales where the transaction price is disclosed. These references will provide some range of value but are not exact markers of your company’s indicated value.
It is useful to utilize several methods of valuation to arrive at expected selling prices for a business. Three of the most common methods include multiple of earnings, asset value and comparable value. To narrow the range, ask yourself the following questions:
- How many years will it take a buyer to get a return OF his or her investment?
- How many years will it take for the buyer to get a return ON his or her investment?
- How many years will it take the buyer to repay the debt he or she borrowed to purchase your business?
It the answers come out between 5 and 7 years (the most common time frame), you’re your business’ fair market value is likely in range and you might have several buyers interested in completing a transaction with you.