No matter what stage your business is in, it’s important to have a plan in place for exiting. You never know when a great offer might pop up, or something might happen to prevent you from continuing on with your business. One of the most important things to get right as part of your exit strategy is making sure your business is accurately valued.
It comes down to two basic principles: your business is worth what someone’s prepared to pay for it, and what you’re willing to sell it for. To get an idea of either and to find the right balance, you need to figure out what area of the ballpark you’re playing in.
Methods of valuation
There are several ways you can go about valuing your business. Which one you choose depends on what kind of business you own, who you’re thinking of selling it to and your reasons for selling in the first place.
Assets plus goodwill
This is probably the most popular way of working out what a business is worth. It’s a pretty basic concept: you add up all your assets such as stock, assets at the depreciated or resale value, any accounts receivable, or cash in the bank. Then subtract any liabilities, such as money owed to others, and possibly any taxes owed if someone is buying the company shares. This gives you your net asset value.
Then you add on goodwill, and this isn’t as easy to calculate. When you’re working it out, it’s important to consider:
- Great relationships with customers and suppliers that will continue.
- Protected intellectual property that gives you an advantage in the marketplace.
- Brilliant location with a secure long lease.
- Good cash flow and no debt.
- Documented business systems and processes a new owner can pick up.
- Loyal, knowledgeable and experienced staff who’ll stay on.
The better these are, the more goodwill you can ask for. And vice versa.
Earning valuation method
Some industries have ‘profit multipliers’ where you multiply past earning by a ‘magic’ number. This sounds unscientific but there are industry-standard multipliers where you look at the average of past profit (say $100,000/year) and then multiply this by 2, or 9, or 17. So your past earnings are used to determine an expected cash flow level, which is then used to predict a sales price.
This depends on lots of factors; quality of product and service, staff that will stay, good lease, happy customers, long term revenue streams/contracts etc. The better these are, the bigger the number.
This method compares your business to others that have sold recently, particularly if they were a competitor. The main problem is that, similar to house buying, the price at times isn’t dictated by the actual value, but by demand. If similar businesses in a similar industry are selling at price x, it doesn’t mean yours should. You could have better clients, products, staff, and future business opportunities.
It’s worth having a discussion with a broker, your accountant, and any other business advisers long before you decide to sell.
Assets resale value
This is pretty much what it sounds like – a business is worth the net assets and what they might sell for. This tends to happen if a business can’t claim goodwill, or if the owner’s so integral to the central operation that the business will probably go under without them.
List all your fixed assets like property, vehicles, equipment, furniture and figure out how much they could be sold for. Remember that assets like property may increase in value over time, while cars depreciate.