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Selling your business? These methods
help you avoid too-low and too-high prices

How much the company is worthDo 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.

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"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."

Setting your price
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.

Figuring the multiples
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 and $400,000.

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 that value."

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.

Plan 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 well spent.

"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 goal."

Jay MacDonald is a freelance writer based in Florida
To comment on this story, please e-mail the
Bankrate.com editors


-- Posted: Jan. 13, 2000

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