15 July 2024: Selling Your Business: More on Valuation
If you’re a business owner beginning to think about selling your business, step #1 is to get a good idea what it’s worth.
You need to know its approximate value for several reasons. One is to calculate your approximate tax liability because, no matter where you are, the government wants a chunk of the sale proceeds to pay for such critical national interests as grants to Chinese surfers and a virtual reality penguin study.
Another reason is to have a sense of whether the net proceeds – that is, the amount the government will allow you to keep – will support the post-closing lifestyle you’s planned. You do have a post-closing plan, right?
WHAT WE’RE LOOKING FOR: Architectural and engineering firms. Revenue: $5 million. Location: U.S.-based
in**@Wo**********************.com
Valuing a small business is a complex yet crucial endeavor that requires a blend of financial acumen, industry knowledge, and strategic foresight. Whether you’re a business owner considering selling or an advisor guiding others through this process, understanding the methods and considerations involved in business valuation is essential.
Business valuation is the process of determining the economic worth of a business or company. For small businesses, this assessment is often more art than science, relying on a combination of quantitative analysis and qualitative judgment. Several key methods are commonly used to arrive at a valuation:
- Asset-Based Valuation: This method calculates the value of a business based on its assets minus liabilities. This is often referred to as “book value”. For small businesses, this could mean valuing tangible assets (like equipment and inventory) and intangible assets (like intellectual property and goodwill).
- Market-Based Valuation: Comparing your business to similar businesses that have recently sold. This approach looks at multiples such as price-to-earnings ratios or revenue multiples within the industry to gauge value.
- Income-Based Valuation: This method estimates the value of a business based on its expected future earnings or cash flow. Techniques like Discounted Cash Flow (DCF) analysis or Capitalization of Earnings models are common in this category.
Knowing which of these methods are most appropriate is important. We often use all of them, if for no other reason than to illustrate and corroborate our conclusion.
__________________________________________________________________________________
Are you a business owner? A Realtor? A business broker? Are you looking for a business to buy? Do you have questions about the selling or buying process, the valuation, marketing the business, deal structure, financing or some other business issue?
You can find the answers in The Brokers Roundtable℠. Our Members include seasoned business brokers, commercial real estate experts, valuation specialists, financing professionals, attorneys, accountants and all the other talent associated with what we do.
Sign up for a 90-day test drive The Brokers Roundtable℠. Access the talent – or just see what’s going on in our industry!
___________________________________________________________________________________
Issues to Consider
Several factors influence how a small business is valued:
- Financial Performance: Current and historical financial data, profitability, revenue growth, and cash flow are critical indicators.
- Market Conditions: The state of the economy, industry trends, interest rates and market demand for similar businesses can significantly impact valuation.
- Competitive Position: The business’s market position, competitive advantages (such as unique products or services), and customer loyalty play a crucial role.
- Management Team: The quality and experience of the management team can affect the perceived risk and value of the business. Employment contracts with the most senior people – even if only one – are sometimes issues in negotiations with buyers.
- Risk Factors: Risks associated with the business, such as an over-reliance on key customers or suppliers, regulatory changes, or technological shifts, are factored into the valuation. For example, if Walmart is responsible for 40% of revenue, red flags will be flying.
Methods and Numbers
No matter which method you use, they all start with numbers. The task is to know – or know how to determine – those numbers.
We’ve written often about the need to know your buyer. Buyers can generally be lumped into two categories: financial and strategic. Different buyers have different goals and look at and for different factors when considering buying a business.
For example, financial buyers are most interested in the answer to the question, “How much will this business put in my pocket?” If the business you’re selling is likely to appeal to financial buyers, determining what that “in-my-pocket” number is, is the first step of the process. In our world, this step is often referred to as “recasting the financials or earnings” or “normalization of earnings”.
__________________________________________________________________________________
Courses! Courses! Courses!
Many of you have asked if our Flagship Course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, could be made available on a module-by-module basis. Instead of enrolling in the complete course, could you enroll only in the module(s) you wanted? We’re happy to report that this is now possible.
We’ve broken our Flagship into six separate modules (or module groups) to give you all the flexibility you need to learn only what you want to learn – and we’ve moved them all over to the new Brokers Academy in The Brokers Roundtable℠ . The Flagship is still available but the modules are now available individually.
You don’t need to be a Member of The Brokers Roundtable℠ to access any of these courses but if you are, you’ll receive a 20% discount on any course you enroll in. If you’re not yet a member of The Brokers Roundtable℠, you can learn more – and get access to all the talent and resources – here.
___________________________________________________________________________________
Recasting the financials acknowledges that neither the income shown on the business’ tax return nor the bottom line of the financial statement is the “in-my-pocket” number. What we have to determine is what is often referred to as “discretionary earnings“, a number that takes into account the value of so-called “owner benefits” in addition to other expense categories.
Normalization adjustments mean adjusting the financial statements to reflect the true economic benefits of owning the business, considering discretionary expenses, one-time events, or non-recurring items. This is the most important component of the Income Method and usually the basis of the Market Method of valuation. And although financial buyers are most likely to assign the greatest importance to this number and these two methods, we always include this data and these calculations, even when the most likely buyer is strategic.
We’ve written previously about financial versus strategic buyers and consideration should be given to both before deciding which would be best for reaching your goals.
_____________________________________________________________________________________
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
Some Challenges
Valuing a small business presents unique challenges compared to larger enterprises:
- Limited Data Availability: Small businesses may have less comprehensive financial records or historical data, making projections more uncertain. This is an issue we see often and urge sellers – and readers of this blog – to get their books in order before bringing a business to market.
- Owner-Dependent Operations: When selling your business, think about how well it is likely to perform if you’re suddenly no longer that the wheel. If the business relies heavily on the owner’s skills or relationships, transferring ownership could be more challenging, affecting valuation. The most basic example of this is its name. If Pete Smith started an auto-parts business 15 years ago and named it Pete Smith’s Auto Parts, a buyer named anything other than Pete Smith might not put as high a value on the business as that exceedingly tiny group of potential buyers named Pete Smith would. Granted, there’s certainly nothing you can do to mitigate this issue but it should be considered in the valuation. (And should have been considered at start-up.)
- Lack of Market Comparables: Finding comparable transactions in the same niche can sometimes be difficult, impacting market-based valuations.
- Subjectivity: Valuation involves judgment calls on factors like growth potential, competitive advantage, and risk, which can vary widely depending on the valuator’s perspective.
The Bottom Line
Each business is different – in location, target market, prospects, history and many other characteristics. As a result, valuing them is as much an art as a science requiring a blend of financial analysis, industry and market knowledge, and judgment. While methods such as asset-based, market-based, and income-based approaches provide frameworks, the true value often lies in understanding the business’s unique characteristics, competitive position, and growth prospects.
Selling your business is likely to be the most significant financial event of your life and the one that will have the biggest impact on your future and that of your family. Consult a professional, at least during the valuation phase. (There’s a bunch of them in The Brokers Roundtable℠.) You may choose to try to sell your business yourself but give yourself a fighting chance at success by avoiding what we refer to as “an unrealistic price expectation”.
Selling any business is a process and following that process will increase your odds of success. We’ve developed a downloadable six-part series of posts explaining this process and it’s available in The Brokers Roundtable℠ in the Resources area.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at
jo*@Wo*******************.com
.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
Searching For…
NOTE TO READERS: Our “Searching For…” feature has been moved to our online community, The Brokers Roundtable℠. It will appear there exclusively from now on.
#business #businessacquisition #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation #MergersandAcquisitions #buyabusiness #sellabusiness #realtor #realestateagents
The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at
jo*@Wo*******************.com