When thinking about selling their company, usually the first question a businessperson asks is “How much is it worth?” Unfortunately, there is no cut-and-dried answer to the question. Entire books have been written about valuation, and there are so many variables involved (and many of them are very subjective) that different experts looking at the same company could end up with different selling prices. There are some commonly accepted techniques and rules of thumb used, which are presented here.
Basically, there are two major ways to figure the price of a small business. One is the company’s ability to generate sales, cash flow and/or profits. The second method is to value the company based on its assets. Which method is used depends on the condition of the business and the industry it is in.
Valuing a business based on sales
In some industries, the norm is to determine value by using a multiplier times the firm’s annual sales. Consulting firms, radio stations, temp agencies, PR or ad agencies, professional practices, retailers and insurance brokers are often valued using a multiplier of annual sales. The multiplier depends on the exact type of business, the predictability of sales from year to year and many other factors. Generally, the industry multiplier is the starting point and is then adjusted based on specifics of the company.
Valuing a company using Seller’s discretionary earnings
The price is based on the company’s ability to generate a stream of profit (which can be defined in different ways) or cash flow (sales less expenses). Many cash flow and EBITA (earnings before interest, taxes and amortization) projections use “recast” numbers to reflect the effect on profits of perks that a business owner takes from the business. This recasting is extremely important.
Valuing a company based on assets
Many businesses are sold under less-than-ideal conditions. What if there are no profits or cash flow? What if the owner passed away suddenly, and there is high financial risk for a new owner taking over? In these cases assets may be used to value the business. The value of the tangible assets usually sets a rock-bottom selling price for the business. Intangible assets may be worth money too – goodwill, customer lists, trademarks, patents, leases, permits and contracts are all intangible assets that can be factored into the price. Many buyers balk at paying a lot for intangibles, but for the seller it pays to evaluate each one for its worth
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