What’s My Business Worth? Part 1: The Asset Method

“What’s my business worth?”

We get that question all the time. And anybody expecting a more-detailed answer than, “It depends…” is likely to be disappointed.

In the 20 years since I founded Worldwide Business Brokers, it has been our experience that the owners of small businesses have a number in mind when they come to us to help them find a buyer. It is also our experience that whatever number the owner has come up with rarely – if ever – bears even the most remote relation to reality.

The owner’s number is generally based either on a completely unsupported guess or it’s what they “need” in order to sell.

For starters, we have to tell these owners that what they “need” is totally irrelevant to both value in general and the buying market in particular. No buyer will give even the slightest consideration to what the seller “needs”. Buyers couldn’t care less.

As to the owner’s “unsupported guess”… well, it’s just that. An owner with no experience or training in business valuation is likely to be as accurate in that task as they would be in estimating the value of an Edgar Degas painting.

Which is to say, not even close.

There are several ways of determining a business’ value and each of those ways can be applied to any business. But understanding how to use the methods correctly and then how to apply the results to determine a value are key.

But both using the methods correctly and applying the results properly are almost never done by business owners. Nor should we expect them to.

They’re not business brokers nor business appraisers. What do they know about valuing a business?!?

This post is the first of a three-part series on valuing a business that was inspired by a recent newspaper article on the topic that I read and which contained too many errors and misconceptions to be of any help to anyone – and, if some of the guidelines were followed, would be sure to produce disastrous results.

Though this series is essentially for business owners, I know that a lot of business brokers could benefit from what is discussed because it not only gets into the “how” but also the “how not” of valuing businesses.

The Asset Method

There are three basic ways to value a business: the Asset, Income and Market methods. This post examines the Asset Method. Next week I’ll discuss the Market Method.

The article I read stated that, “The asset approach to valuation may be the most straightforward method because it is based directly on the value of a company’s assets less any liabilities it has incurred.”

A quick look at any publicly-traded stock will illustrate the fallacy of that statement.

Stocks are priced – that is, businesses are valued – based on earnings. That’s why stocks are quoted on a P/E, or price-to-earnings basis – the Income Method.

As I write this, Apple is valued at $2.3 trillion based on its current share price of $131.97. That is to say that buyers are paying $131.97 for a single share of Apple and that if all the outstanding shares where available to be bought – and they are on any given day – the total value of the company is $2.3 trillion.

But the determination of share value is based on what buyers are willing to pay for Apple’s projected earnings. As of the end of October, Apple’s earnings were $3.67 per share. Therefore, buyers of Apple are paying roughly 40.4 times per-share earnings for a share. Hence, Apple is selling at a P/E ration of slightly more than 40.

Part 2 in this series – the Income Method – explains this in greater detail and why that method is the primary basis for valuation in our business.

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Though the Asset Method is certainly one way to value a business, businesses sold for the value of their assets are generally businesses with earnings that are so low – or nonexistent – that the value of those earnings is less than the value of the assets that produce them.

This suggests that the assets might be used more profitably if they were producing something else – or in the hands of better management – a condition that further suggests that the business that owns the assets is in trouble.

The asset approach is used in certain circumstances, most notably – but not exclusively – in distressed or bankruptcy situations. But some businesses are more valuable when broken up and, in certain circumstances a business may be asset-heavy.

How the asset approach impacts value depends on various aspects of the assets. Are they tangible or intangible? Will the assets have to be moved? If so, what is the “in-place” value versus the “relocation-value”? Are the assets obsolete or nearing obsolescence? Are the assets intellectual property such as a patent or trademark?

In our experience, if the Asset Method of valuation results in a business’ highest value, we’re looking at a turn-around situation or, in the worst of cases, a liquidation.

The Bottom Line

We often use the Asset Method of valuation as part of our valuation process but the result of this method is almost never a legitimate consideration in our final calculations.

Financial buyers are almost always interested in the answer to this question: “How much money will this business put in my pocket?” And the buyers of most small businesses – those with valuations of under $2 or $3 million – are financial buyers. As you will see in next week’s post, this suggests that the Asset Method of valuing a business is, in most cases, much less important than the Income and Market methods.

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

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The author is the founder 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 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com