What is my business worth? A business valuation primer.

Posted by on Friday, February 19th, 2016 in Uncategorized

What is my business worth? A business valuation primer.

What is my business worth and what is a business valuation?  As a business exit strategist, I hear that question all the time. There are two answers. First, whatever a willing buyer will pay you. Second, well, that’s a bit more complicated. Most business owners decide to exit their company when something bad has happened. An economic downturn, health issues, divorce, and industry disruption are all reasons owners decide to sell. They’re all bad reasons. Deciding to sell when your business is “at the top” is a good reason. With good planning, you can sell your business at the top for top dollar.

 

This post is intended to provide you with a quick simple business valuation formula to use when exiting your company. Selling or exiting your company is a complex process that needs to be handled with great care. Business owners should seek competent counsel in preparing an exit plan.

 

There are three types of buyers. Financial, strategic and tactical. The financial buyer is often an early retiree looking to invest a 401K or IRA into a business and work for himself. He is interested in two things. The return on his investment and the growth potential of your company. Show him a good return and have an active growth plan in place and he’ll agree with your business valuation and buy your company.

 

The strategic buyer is buying a competitive advantage from you. Perhaps your company has a customer, technology, method or geographic presence that he needs and is willing to pay for. This type of buyer has a business valuation based on him needs not you or your company.

 

The tactical buyer is an industry buyer that probably knows you and your company. His motivation to purchase is based on keeping someone else from buying you. Much like the strategic buyer, his business valuation is based on his needs, not your or your company’s.

 

Using these facts you can prepare a valuation conclusion based on your business in each scenario.
The simplest business valuation methods take net income and add back personal expenses the company for you and your family, then add back amortization, depreciation, interest and taxes paid. Once you have this number multiply by 3. If you are selling real estate with your business add the value of that to the equation above. If your business has high inventory value add that as well. Also, consider your accounts receivables. these are yours. Although you’re not going to add these to the asking price of your company you can add that to the net amount you’ll be making one the sale is complete because you get to final keep your working capital.

 

Let’s assume your small business doesn’t have significant inventory and you don’t own business real estate. Say your business grosses $600,000 a year and the business has $425,000 in expenses each year. But $25,000 of those expenses are personal expense like your wife’s car and dinners with the in-laws. (Keeping clean books is only one of the reasons to not put personal expenses in your business) You have to add that $25,000 back into the net income. So the real business expenses are only $400,000, even though your P&L shows $425,000 for tax purposes. The amortization, depreciation, interest and taxes expense is $40,000. So your adjusted profit for business valuation purposes is $240,000. Multiply this by 3 and your company is worth $720,000.

 

Pull together your tax returns and do the above on your business’ income over the last three years. Run a few reports. What was the adjusted profit from the past few years? Is it rising or falling? Why? If it’s increasing, you want to explain your growth plan and show how it will continue without you. If it’s declining, you need to explain why. And you should implement a plan to reverse the declining trend. Preferably a plan a new owner can continue.

 

If the adjusted profit is rising, you can easily ask for 5 times adjusted. So, in the example above, you should be able to ask $1,200,000 if that income is increasing. If the adjusted profits are declining, you’ll be lucky to get 2 adjusted profits.

 

Adding value by implementing a growth plan will make the buyer feel comfortable and put more money in your pocket.

 

The simplest most effective way to add value for you and the buyer would be to implement an Exit Plan that includes a full assessment of your company and industry as well as cost savings and growth plans. This provides you with a detailed insight into your business and industry as well as a checklist for increasing your company’s adjusted profit and ultimately the purchase price.

 

There are many companies and individuals that offer business valuation services but look for one that guarantees their work. Spend the time to vet your options it may be one of the biggest and most profitable decisions you’ve ever made.

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