- July 28, 2014
- Posted by: Business Brokers & Consultants
- Category: Business Valuation
In our last article we discussed just how important it is to disclose the motive for obtaining a business valuation. Valuations may be required for estate planning, due to divorce or partnership dispute, or for a number of other reasons.
In most cases, however, when a business owner comes to me and asks me about the “value” of their business- what they really want to know is “what do you think I can sell it for?”
I wish the answer to that question involved a formula like “Multiply the number of hours you have put into this business by 1,000 and the amount of capital you invested by 2. For every family event you missed to take care of business, add a million dollars. Apply a multiple of 10 for every day you didn’t quit when the going got tough, and instead toughed-it-out. That’s what your business is worth.”
Like I said, I wish that was the formula. Unfortunately, it’s not.
The “Fair Market Value” of a business is: “The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the later is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” This is the definition used by most courts and it’s the basis for most valuations.
Now, that’s a catch-22, isn’t it? The very definition of “Fair Market Value” begins with “The price…,” the very thing that you don’t know until after the sale is complete. So- how exactly do appraisers place a value on a business?
In the case of an on-going business concern, the Valuation Analyst will typically use a combination of Market and Income Approaches to make a very “educated guess” at the value the business. The Market Approach considers the prices paid by investors for similar companies in the same or like lines-of-business. The Income Approach considers the value of the business based upon the expected future income, divided by the rate of return. This, of course, requires analysis of historical data and financial records.
A certified appraisal has value in the negotiation phase of selling, however, it is not a requirement for listing your business. If you just want an idea of what your business might bring in today’s market, BB&C can help you with that. We use a combination of debt service ratios, capitalization calculations, and similar business sales in our calculations as well. However, our report is not a certified appraisal, and is prepared only for your contemplation. It is provided free of charge in order to give you an idea of what you can reasonably expect before making the decision to sell.
So, the formula for taking an ‘educated guess’ at the value of your business is actually more like, “determine the historical discretionary cash flow of the business, deduct future debt service and a reasonable salary for the new owner, then determine if the capitalized rate of return on the initial investment makes sense……” Probably not what many business owners want to hear. As a fellow business owner, I like the first formula better myself. Never-the-less, I believe our seller cleints should enter into the sales process with their eyes wide open. And having a realistic expectation of your company’s value is fundamental.
If you are considering the sale of your business, I would be happy to help you better understand the valuation process and what your business is worth. I can also provide you with insight about how to better position your business for a future sale.