Selling your business? These methods
help you avoid too-low and too-high prices
you know the value of your business?
Most small business owners today have only
a vague sense of their companies' worth -- and little wonder. Assessing
the value of a business is usually a time-consuming prelude to a
major change. Whether you are looking to sell your business, merge
with another company, justify a bank loan, lure investors or simply
pass the torch to your heirs, the first step is to determine the
current market worth of your business.
Just as it is unwise to be your own doctor or
lawyer, it can be shortsighted and often costly to price your business
yourself, according to Russell Robb, author of Buying Your Own
Business and editor of M&A Today, a mergers and acquisitions
newsletter. Most business owners only sell one company in their
lifetime, and it usually represents their life's work, he notes,
while corporate buyers are often singularly focused and highly skilled
at negotiating the deal.
"The biggest mistake owners make is in not hiring
a professional to help them do it," Robb says. "They can't understand
what the values are because they've never sold a business before.
They may decide their business is worth $10 million, only to learn
too late that they could have gotten $20 million for it."
There are several ways to determine your business's value. Each
offers a different perspective; together, they lead to an approximation
of true market worth.
The method or methods you use will depend on
the nature of your business and the industry you're in. Keep in
mind that most prospective buyers will be using their own formulas
to arrive at a starting point for negotiations. Often buyer and
seller will collaborate on certain parts of the appraisal process
in order to move the deal along faster.
The more popular valuation methods are:
- Asset valuation: This method appraises
the value of a company's assets as the sum of all fixed assets
and equipment, improvements to the physical plant, inventory and
owner benefit (the owner's discretionary cash for one year). Asset
valuation is most often used in asset-heavy industries such as
retail and manufacturing.
- Market valuation: Remember when you
bought your home and your real estate agent showed you "comps"
-- comparisons of what similar homes in your neighborhood sold
for recently? This method takes a similar approach for businesses
by using industry-average sales figures as a multiplier. But just
as housing "comps" overlook the very real differences in properties,
the multiplier approach may overstate or understate the true value
of your business. For example, it is not unusual today for Internet
businesses to sell for 50 times their estimated gross, even though
they have yet to make a dime.
- Capitalization of income: This method
focuses exclusively on cash flow and return on investment (ROI),
taking into account important intangibles such as work force and
management, turn rates, industry trends, sales projections, and
the market position and maturity of the business. The end result
is a multiple of earnings, based upon the buyer's desired rate
of return. It indicates a likely market price and the time frame
in which the new owner might expect to recoup his investment.
- Owner benefit valuation: Most often
used for businesses whose primary value comes from their ability
to generate cash flow, this formula takes the owner benefit (the
seller's discretionary cash for one year) and multiplies it by
2.2727 to achieve a market value. The multiplier is based on a
10 percent ROI, a living wage of 30 percent of owner benefit and
25 percent debt service.
For many small businesses, a rough multiple of 3-1/2 to 4 times
gross annual earnings may come close to their market worth, according
to Michael Dougherty, a business broker with VIP-Lodge
McKee Realtors in Naples, Fla. That means that if your store
made $100,000 last year, it might go to market at between $350,000
But not necessarily.
"If somebody is making an investment, they're
usually looking at a multiple of earnings based on a passive investment,"
says Dougherty. "If the owner manages the store, the new owner would
be looking to hire a manager at $35,000 a year, so that $100,000
suddenly becomes $65,000. So the business is worth 3-1/2 to 4 times
According to Robb, the multiple can, and should,
adjust from business to business.
"The multiple of earnings varies according to
many aspects, including the company's history, the industry, market,
management, potential, proprietary products, niche, growth rate
and size," he explains. "The multiple also depends on the buyer's
desired rate of return. For example, a 5 multiple represents a 20
percent ROI while a 4 multiple represents a 25 percent ROI." In
other words, it would take the buyers five years to recoup a 5-multiple
investment, four years for a 4-multiple investment, and so on.
ahead and prosper
It takes up to two years to correctly price and position a business
for sale, according to Robb. It may seem strange, but much of that
time should be spent extricating you, the owner, from the day-to-day
operation, in order to obtain the best selling price.
"One of the biggest problems is that the owner
is so important that he's a one-man band and without him the business
is nothing," says Robb. "He's got to start phasing himself out and
get management in place so that it works like a smooth-running clock.
He should try to convince the buyer that he takes a six-month vacation
and the place runs just fine without him."
Dougherty says the cost of a business broker,
typically a 10 percent to 15 percent commission at closing, is money
"People get emotionally involved in their business
and have a tendency to think it's worth more than it is," he says.
"Only a professional can help steer them toward their financial
Jay MacDonald is a freelance
writer based in Florida
To comment on this story, please e-mail
-- Posted: Jan. 13, 2000