 Selling or
handing down your business? How much is it worth? You need to know its
value. Get a free business valuation.
Setting the right price with the right
terms are the most critical factors in selling your business. If the
price is too high, your business won’t sell. It doesn’t matter how good
the business is or how much potential the business has, it won’t sell.
If the price is low, you will be leaving a lot of money on the table.
Our free business valuation gives you a
thorough assessment without costing you anything when you list your
business with us. Those who don’t list with us are billed $650 for this
service.
There are several approaches to valuing
your business.
Balance Sheet Value
There are several balance sheet valuation methods, including adjusted book
value, book value and liquidation value. The adjusted book value is determined
by revising the asset’s book value to reflect the cost it would take to replace
the assets in their current condition. This method requires the total values to
be offset against the sum of the liabilities.
The
book value considers the figures from the company’s financial records, as
depreciated at the time of the sale. The book value can pose some difficulties
for sellers, particularly if the seller has depreciated the assets too much to
gain prior tax advantages.
The
liquidation value is the amount that could be realized if all assets –
equipment, furnishings and inventory – were sold separately. This value is
typically much lower since it doesn’t consider a company’s intrinsic value.
Income Approach
The
income approach takes into consideration the company’s level of earnings using a
capitalization rate, discount rate or multiplier. Several income approach
methods are frequently used. Each method requires a level of earnings and a
conversion factor to translate the earnings into a company value. Selecting the
proper level of earnings – after-tax, pretax, discretionary or cash flow – and
matching it with the proper conversion factor – discount rate, cap rate or a
multiplier – is critical to calculating a reasonable value.
Market Approach
The
market approach sets a value based on the values of other businesses that have
been sold. Setting the market value involves researching the sale prices for
similar businesses in a geographic area. In some cases, however, finding a
company that is similar in many ways to your company may be difficult.
Whatever your goal, you want a good advisor to
help you assess the value of your company. Question your advisor on the effects
of deal structure and how multiples are used. A business owner should never
accept a computer-generated valuation or a one-size-fits-all approach when
selling the business. And don't be impressed by the person who presents the
highest value – you may only be setting yourself up for failure during the sale
process.
The main reasons to obtain a business
valuation are:
- Planning for sale – The first and
most important step in packaging.
- Obtaining financing
- Divorce litigation, dissolving
partnership
- Gift tax / Estate tax planning
- Conducting annual reviews
- Maximize vendor and supplier terms
- Documented base value for multiple
insurance applications
- Report to investors in a private
firm
- Plan for a merger or stock offering
- For the creation of an employee
stock ownership plan (ESOP)
To know why it’s so important to have a
valuation you must understand that the book value reflected on the
financial statements of a business usually differs vastly from its true
market value. Ultimately, the business is worth what the market will
bear. This means that the business is worth the highest price a buyer
is willing to pay.
We have valued and sold many types of
businesses. If you are serious about selling your business,
RealNova Brokers & Associates will work with you to price your business right.
Free Business Valuation Estimate in
less than 15 minutes:
Click here to get a quick view of your current
business value.
Top 5 Business
Valuation Myths
As you work tirelessly to meet the everyday
challenges of running your own business, you may wonder why you should be
interested in a column on valuing your business. After all, valuation is
something you will be concerned about some time in the future when there is
"need" for a valuation. If you feel like this and you stop reading, you will be
missing an opportunity to insure that your business will survive and prosper.
Understanding the factors that determine the
value of any business will pay tangible dividends by focusing you on ways to
increase your firm's short and long-run profitability. Moreover, if you choose
to sell your business at some point in the future, this knowledge will assist
you in positioning your company to receive the highest price. Therefore, there
is no time like the present to begin to understand what a business valuation is,
under what circumstances a valuation is customarily completed, and the critical
issues to watch out for when events dictate that you undertake a business
valuation.
Myth I:
Valuing a private business should only be done when the business is ready to be
sold or a lender requires a valuation as part of its due diligence process.
Although the business sales and lending processes generally require that
valuations be completed, if these events represent the first time an owner has a
valuation completed, then you can be sure critical business and estate planning
issues have not been addressed. If the business is to have a life beyond that of
its current owners, then effective planning for ownership transition requires a
regular valuation of the business.
Ownership transition may include gifting some
percentage of ownership shares to family members during the owner's life, thus
reducing any tax on the owner's estate at death. If a firm has several owners, a
buy-sell agreement with accompanying life insurance should be in place so that
if an owner dies, the remaining owners have sufficient funds to purchase the
deceased owner's interest at an agreed upon value. The buy-out value under these
agreements should be updated regularly to reflect the firm's financial progress
over time and the valuation approach used should be one of several acceptable to
the IRS.
Myth II:
Businesses in my industry always sell for two times annual revenue (the revenue
multiple). So why should I pay someone to value my business?
The short answer is that data on selling prices indicate that revenue multiples
within an industry are generally all over the lot. These rules of thumb used by
business brokers, the individuals who often facilitate private business
transactions, are median multiple values. The median value indicates that half
of the revenue multiples are below the median value and half are above. Thus,
the median value is just a convenient midpoint and does not represent the
revenue multiple for any actual transaction. Unless the firm that is being
valued is truly a median firm, then using the industry rule of thumb for this
purpose is clearly wrong.
For example, according to a well- known source
for business transaction data, Pratt's Stats, recent revenue multiples for firms
in the auto parts industry ranged from a low of .98 to a high of 83 with a
median of 2.9. If you were valuing your firm for sale and your annual revenue
were $100,000, then the value of your business could be as low as $98,000, as
high as $830,000, or somewhere in between. Where your firm lies along this
continuum is obviously of the utmost importance and can only be determined by a
valuation approach that incorporates academically validated methods with
industry-specific valuation factors. Myth IV below discusses the legal and tax
implications of assigning a value to your firm that is outside a permissible
range.
Myth III:
A local competitor sold his business for three times revenue six months ago. My
business is worth at least this much!
Maybe yes and maybe no. What happened six months ago is not really relevant to
what something is worth today. What your business is worth today depends on
three factors: 1) how much cash it generates today; 2) expected growth in cash
in the foreseeable future; and 3) the return buyers require on their investment
in your business. First of all, unless your firm's cash flows and growth
prospects are very similar to the competitor firm, that firm's revenue multiple
is irrelevant to valuing your firm. Moreover, without getting into the nuances
of finance, even if the competitor firm was equivalent to yours in every respect
and both firms were sold today, if interest rates were higher today than 6
months ago, the firms would likely sell for less than three times revenue.
Conversely, if rates were lower today than six months ago, the firms may be
worth more than three times revenue. In short, the value of your business is
likely different today than six months ago because economic conditions have
changed.
Myth IV:
How much a business is worth depends on what the valuation is used for!
The value of a business is its fair market value (FMV). According to the
Internal Revenue Service, the FMV is what a willing buyer will pay a willing
seller when each is fully informed and under no pressure to act. While there may
be a FMV range, the wider the assigned valuation range is, the less reliable is
the valuation and the more likely it becomes that the valuation will face
greater scrutiny from potential buyers or the IRS.
Consider the example of a parent selling a
business to a child. The incentives to assign a low valuation under these
circumstances are significant. Given that the parent pays taxes on the
difference between the value of the stock sold to the child and its value on the
firm's books (book value equity), establishing a low value on the firm's stock
results in the parent minimizing the capital gains tax owed to the IRS. The
child, on the other hand, has to come up with less money, because the sales
price of the business is much lower than its FMV. These types of transactions
are common and the IRS is always looking for abuses. Alternatively, an owner of
a business may make a charitable contribution of company stock. In this case,
there is a significant incentive to place the highest possible value on the
donated shares, because this will result in the largest charitable tax
deduction. If the value of the donated shares is outside the FMV range, an IRS
audit may well be in the donor's future.
Myth V:
Your business loses money, so it is not worth much.
Most private businesses appear to lose money. Appearances, however, are often
misleading. Not long ago, a potential buyer was considering buying an auto parts
business in Georgia. The asking price was approximately $950,000 and, according
to the firm's tax return, it hardly made a profit. Like many businesses of this
type, this business was generating a great deal of cash, but this cash was
masquerading as legitimate expenses. One expense category really stood
out—payments to officers. This payment included the owner's wage of $80,000 per
year and a bonus of $150,000 that the owner paid himself at the end of year. The
$80,000 wage is what the business would have to pay a stranger to do the same
job as the owner. This was a real expense. The $150,000, on the other hand,
represents what finance people call a return to capital. It is the cash the
business generated and it is this cash that determines the value of the
business.
Unlike public companies, the separation between
ownership and management does not really exist in a private firm. Thus owners
have some discretion over how they categorize cash flow generated by the
business. Quantifying the size of these discretionary expenses is often a
critical determinant of the firm's value. As such, owners should keep a tab on
what these discretionary expenses may be so that, when they are ready to sell
the business, they can document these facts to the buyer. By doing so, the
seller increases the buyer's confidence that the business does legitimately
generate the cash the seller claims and, accordingly, increases the buyer's
willingness to pay the asking price for the business.
In the final analysis, there are many important
reasons that business owners should know the value of their businesses long
before they decided to sell. By understanding the basics outlined above, you
should be able to successfully plan the financial future of you and your family
by understanding the value of your most important asset—your business.
Fee–Based Valuations: For more elaborate, paid valuations, we
use an independent third party valuation firms that
specialize in privately held companies and small business valuations.
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