How Does A Business Valuation Work?
Valuing a business can be a complicated and time-consuming process, because every individual business and industry is so different. Depending on the situation, small to mid-sized businesses are typically priced for sale in one of two different ways. Either it’s based on a multiple of the owner benefit/discretionary earnings or it's priced at its asset value.
Multiple of Owner Benefit
Using the last 3 years of business tax returns (or Profit & Loss Statements if tax returns are unavailable) we go through a process known as a financial recast, to add back in 1 owner’s salary, non-essential business expenses or personal expenses, interest, depreciation, and amortization. Once the recast is finished, then we can see the true owner benefit/discretionary earnings of the business. Then the owner benefit/discretionary earnings is multiplied by its respective industry multiplier. Looking at comparable sales to find the multiple is the most accurate way to value a particular business, because they represent actual comparable sales. This multiple is a ratio of sales price to owner benefit/discretionary earnings.
In the case where the business isn’t making enough owner benefit to attract buyers, then we would take a look at the asset value. In this case, the value of the business is based on the fair market value of the tangible assets that the business owns. If the business’s tangible assets are worth more than the multiple of the owner benefit/discretionary earnings, then the business should be sold based upon the market value of the tangible assets. The buyer is not paying for goodwill or any other intangible assets; however, in these cases, they are often included in the sale anyway.
A Business's Value To A Buyer
A buyer will always question whether or not a list price is fair, so you want to be able to defend your asking price. At the end of the day, a business is only worth what a buyer is willing to pay, so the asking price needs to be justifiable and easy for a buyer to see the value in it. A common saying among business brokers is that buyers pay for the past, but they buy it for the future. Meaning that the value the buyer is paying for is based on the past performance of the business, but they are buying this particular business because they believe it has a future that they want to invest in. The average small business buyer is looking to earn back their investment in 3 years or less.
The Importance of Getting Value Right
When listing your business for sale, it’s important to get your business’s value correct and your asking price right from the very beginning. The average business sale takes about 230 days to sell, and businesses that are priced correctly sell much faster. Statistically, the majority of the businesses for sale will actually never sell, and much of that is due to the fact that they are unfortunately over-priced. In fact, it is estimated that only 25% of businesses currently on the market will ever sell, and Green & Co. sells 82% of the businesses we list. Why is our success rate triple the average? It’s not just our superior marketing and team of brokers who go the extra mile, but we recognize the importance of getting the asking price right from the very start. Working with an experienced business brokerage to get their expert opinion of value, based on real market data, will give your business the fighting chance it needs to see a successful sale.
Free Business Valuation
At Green & Co. we get many calls from business owners asking, “Can you value my business?” and the answer is almost always "yes". We are happy to offer a completely free business valuation to people who are considering selling their business with us. You do not need to pay a broker or a CPA thousands of dollars to do this for you, as it is always included as part of our services. Give us a call today or contact us using the form below, and we can get the process started for you.