Small Business Questions & Answers


Filed under Running Your Business

Ask How To Value a Business

by Hawaii Bound | May 24, 2012

Subject :Business Entities and Not-for-Profits

Dear Toolkit,

I'd like to leave it all behind and sail to I need to know how to value my business to arrive at a sale price. And I'd also like to know what to look for when buying a business someone else has put a value on...just in case I come upon an opportunity in the land of endless summer. Can you help me chart this course?

Hawaii Bound

Dear HB,

Sounds like a plan, but before you cast off you've got a lot of homework to do.

For starters, the value of your business should, of course, be greater than the total values of its hard assets. Unfortunately this is often not the case with many small businesses. But for a buyer, the key is typically that an ongoing business has everything necessary--equipment, location, and inventory if applicable, not to mention experienced employees, suppliers, business processes, and a customer list--all in place, in the right amounts for successful operation of the business.

But how do you put a price on this intangible asset, which is frequently referred to as goodwill or going-concern value? Moreover, how do you determine the true market value of the hard assets used in your business? One answer is to hire a professional appraiser. These people have the objectivity and know-how to be able to set a price that is neither unrealistically high nor inaccurately low.

But remember that value is in the mind of the beholder. A professional valuation can tell you the price that an average buyer might pay for your business. However, when it comes to negotiating with an actual buyer, the appraisal is just a starting point.

A particular buyer may have a strong strategic reason for acquiring your company, and may be willing to pay a premium over what the average buyer might offer. Another buyer might simply be looking for certain assets to augment his or her own business, and may not be willing to pay for your company's going-concern value at all. It's important that you size up any potential buyer's reasons for acquiring your business before stating a price.

If you feel a professional valuation would be too expensive, you can try to create your own appraisal of your business's worth. Let's start with the basics. Business valuation methods fall into the following categories, depending on what their major focus is. Click on the links to learn more about each method.

  • business assets, including book value and liquidation value methods
  • historical earnings, including debt-paying ability, capitalization of earnings or cash flow, gross income multipliers, and dividend-paying ability methods
  • a combination of assets and earnings, namely, the excess earnings method
  • the market for similar businesses, including comparable sales, industry rule of thumb, and p/e ratio methods
  • future earnings, namely, discounted future cash flow or earnings methods (My first choice!)
  • Interactive Business Valuation Calculator, a tool to determine the value of future cash flow

An excellent tool to help you with this do-it-yourself project would be a copy of a useful book authored by Dr. Stanley Feldman, Dr. Timothy Sullivan and Roger Winsby titled, What Every Business Owner Should Know About Valuing Their Business, and published by McGraw Hill. This up-to-date and inexpensive book can help you document business value to prepare for a sale or for a succession plan or even a divorce proceeding. It has industry-specific case studies as well. The entire book is presented in plain English and is also easily understood by non-math majors.

I believe that once you've digested this book you will have learned that a formal valuation, whether homemade or professionally done, will not only help you with a sale or succession plan, but also force you to consider some further ramifications of maintaining this value. A valuation may suggest you need to better insure yourself, your business or even key employees. Or it could even suggest some serious estate planning is called for.

If you get stuck in your efforts to be self-reliant, there are a host of competent business appraisers you can retain to help you. For example, the authors of the above book operate Axiom Valuation Solutions. Or perhaps your lawyer, CPA or banker would be willing to review your homemade appraisal and comment on it before you finalize your strategy for selling (or even buying) a business.

This is a complex topic, but considering how much time, effort and money you've invested in your business, knowing how to value it is of critical importance and well worth some serious study and consideration.