In many respects, there is no way to put a value on your business. It simply is not possible to put all of the vision, hopes, dreams, successes, failures, and years of hard work that tell your story as a business owner under the umbrella of a dollar amount.
However, no matter how powerful the story, part of being a successful business owner is having a solid idea of what your business is worth at all times. Maybe you are trying to attract investors, or perhaps you need to take out a bank loan with your business as collateral. Or maybe an offer to buy comes along that is too good to be true and you need to confirm or reject your suspicions.
The sad reality is that many small business owners are woefully ill-positioned to provide an accurate estimate of what their business is actually worth. By considering the 6 business valuation tips listed below, business owners can keep themselves one step ahead of the market and leverage their business for every penny it is worth.
Have the Right Documents
When it comes to determining a business’ value, it is impossible to create an estimate without having all of the facts in place. Investors, lenders, and buyers are all going to want figures that support the number you propose.
Therefore, the following are some key support documents to have readily available at all times:
- Tax returns, balance sheets, and profits & loss statements for the last three years
- Average value of saleable inventory on hand
- Value of equipment
- Copy of tax bill and real estate appraisal, if owned, or lease information, if renting
Valuation is More than Capital Assets
While the aforementioned documents are critical as a means of support, they should not be the foundation on which a business valuation is built. Too often, business owners look at the cash value of the stuff they have on hand, such as real estate, inventory, and vehicle fleet, and assume that this is the sum of what the business is worth.
However, most capital assets have little value independent of their role in producing revenue. For example, construction equipment and heavy machinery are extremely expensive, but nobody will buy them if there is no market for construction. Therefore, capital assets should be avoided when calculating a business’ worth, with the focus kept on revenue potential.
There are many reasons people start a business. Some start their business to fill a need in the market, while others may have more altruistic motives, such as providing a more environmentally friendly option for consumers.
Whatever the case, the key driving force that keeps business’ lights on is profit. If you are losing money, you aren’t going to last. As such, potential buyers are going to want to know exactly how much your business made in the most recent fiscal year. This profit, or net income, is calculated by subtracting all expenses from gross revenue.
A snapshot of a business’ current profits far from tells the whole story on how to value a business, as prospective buyers are going to want to assess the business’ future profit potential. This is where multiples come in.
Earnings multiples reflect the risk attached to future earnings. A low-risk business will have a high multiple, as evaluators are willing to accept that profits will continue years into the future. A high-risk business will have a low multiple, as it may be difficult to envision profits continuing more than a year or two down the road.
The typical range for most small to midsize businesses will be a multiple between 2.0 and 10.0.
Create Your Own Estimate
Now it is time to put a dollar amount on what your business is worth. This will usually consist of several steps:
- Establish net income for the current fiscal year
- Determine the multiple
- Adjust future income based on projected growth of the business and market
As an example, consider a business that has a current net income of $200,000, a multiple of 5.0, and projected growth of 10%. A rough breakdown of the the business’ valuation would be:
- Year 1 – $200,000
- Year 2 – $220,000
- Year 3 – $242,000
- Year 4 – $266,200
- Year 5 – $292,820
The sum of all of this future income is $1,221,020. This will provide a ballpark figure of what the business is worth.
Get a Feel for the Market
Unfortunately, the steps for how to sell a business are not quantitative. At the end of the day, your business is worth what buyers say it is worth. Maybe a buyer doesn’t agree with your growth projections and multiple, or maybe you are in an industry where capital assets carry heavier weight in the market.
This is why it is important to use comparative statistics and see what similar businesses have recently sold for. This can help you determine whether it may be necessary to accept a lower figure than what you originally calculated or if it may be possible to charge a premium for your company.
How to Correctly Value Your Business
Valuing a business is never easy. Equal parts art and science, successful business owners can use the 6 points listed above to help them come to a reasonable figure should a price tag on their company become necessary.