[UPDATED: 11/3/2020] Many tools and formulas exist to help you determine the selling price of your business. However, since situations vary from business to business, getting accurate figures off of these solutions can be a challenge. According to experts, only two things influence the final price: how badly a potential buyer wants to buy, or how strongly you want to sell.
The business’s true value is determined when a willing buyer and willing seller agree and bind their decision with a contract. However, knowing your business’s value before setting up a meeting can allow you to get a better deal – that’s where valuation calculation comes in.
But many small business owners set a price without performing a proper valuation. Unfortunately, this only slows down the sales process. If your price is too low, prospects might assume that something is wrong with your business. If it’s too high, they will look for other options. So, ensure you complete a thorough valuation for a smooth sale.
It’s a good idea to hire an investment banker or business broker to do the valuation. Although no one knows your company better than you, an independent expert will use their experience and expertise to set an objective baseline expectation of the sale price. A business broker will also be able to:
- Estimate the worth of all the assets
- Gauge your company’s resale value
- Obtain a true company value
- Have access to databases that have crucial financial details about recent financial transactions involving similar companies
- Identify opportunities or issues that you never knew existed in the first place
- Help you identify tax and accounting issues to better position you for sale
If you decide to do it alone without a banker or broker, then you should at least get a business appraiser before listing the business for sale.
Usually, the best estimated value will be a range, as opposed to an exact figure. So expect something like $1.5 million to $1.8 million. But as we mentioned earlier on, the amount that the buyer pays is basically what your business is worth.
Determining how much to sell your business for
There are two main ways to determine the price of a small business. The first one is your company’s ability to generate sales, profits, and cash flow. The second involves valuing the business based on its assets. The right method for you will depend on the type of business, its condition, and the industry.
Asset valuation, cash-flow analysis, earnings multiples, and sales multiples value the company’s financial side. Nonfinancial considerations also apply. For instance, your teashop might be worth a lot more to a buyer if it’s next to the prospect’s restaurant, because of the combined business element playing a factor in their decision.
This valuation method can apply when your business is being sold under less-than-perfect-conditions. Like when there is no cash flow or profits or when you can no longer run the business, and there’s a high financial risk for someone new taking over. In this case, the tangible assets determine the basic selling price for the company. Intangible assets like trademarks, patents, intellectual property, customer lists, permits, leases, and contracts may also be worth money.
Pricing with asset valuation
You can price your business using the asset valuation method by computing the Net Book value less any lost value. So, let’s say your assets give a Net Book value of $1.5 million, but your equipment’s value has dropped from $300,000 to $200,000 after years of use. You’d subtract the loss from net value to get the final price of $1.4 million.
Using gross sales
Industries like ad agencies, radio stations, consulting firms, temp agencies, insurance brokers, and professional practices use multiples of gross sales as a valuation method. The multiples of gross sales vary based on the business, sales predictability from year to year, etc. In general, a business starts with the multiplier and adjusts depending on industry specifics. For instance, the multiplier might be three times sales. But if the company has seen steady and robust growth in the past few years, it may boost the multiplier to 3.5 or more.
Using the discounted cash-flow approach (DCF)
Some businessmen use this valuation method to determine the value of their business. The cash-flow analysis looks at the money that the company generates annually, projects it into the future and discounts the future cash flow value today. It uses data from a cash-flow statement to highlight cash flow into and out of the business over a specific time. DCF estimates the money you’d get from your business, adjusted for the time value of money.
Pricing with discounted cash flow
DCF applies in any situation where a prospect pays money today, expecting to receive more money in the future. So, assuming a 5% yearly interest rate, $2.00 in a savings account will amount to $2.05% annually. But if the $2 payment delays for a year, its present value becomes $1.95 because it can’t be placed in your savings account to generate interest.
The DCF formula is:
Where CF =cash flow
n = period/year number (usually five years)
r = discounted rate (or Weighted Average Cost of Capital [WACC])
So, if your WACC is 5%, and have an initial investment of $10 million, you can calculate the value using DCF this way.
|Year||Cash flow (in millions)|
|Year||Cash flow (in millions)||DCF|
Adding all the DCFs, we get a total of $13,306,728. And when we minus the initial investment of $10 million, we get the net present value of $3,306,728.
Revenue is the crudest way to value a business. If your company sells $50,000 annually, you can think of it as a $50,000 revenue stream. Usually, the value of a business is a multiple of its revenue. Depending on the industry, the business can sell for “one times sales” or “two times sales,” and so on. An experienced business broker can help research sales multiples in your industry.
Using the earnings multiples (price-to-earnings)
Revenue doesn’t translate to profit. Think of it this way. How much will a prospect be willing to pay for a business with recurring $500 million annual revenue that they have to pump an extra $30 million annually to keep it afloat? Earnings multiples work this way: first, the net income or profits are determined. Then, Earnings Before Interests, Taxes, Depreciation, and Amortization (EBITDA) or interests and taxes [Earnings Before Interests and Taxes (EBIT)] are taken out of the basic earnings. Lastly, the final earnings number is multiplied by the number of shares.
If yours is a sole proprietorship or professional practice, then you can use discretionary earnings (SDE) where gross profits are obtained by deducting different costs. EBIDTA calculates the value of large businesses while SDE is for smaller ones.
Pricing with multiples of earnings
In this example, we’ll use the price-to-earnings (P/E) ratio to calculate the price. The P/E ratio measures your business’ current share price in relation to its current share earnings (EPS). Investors and analysts check the business P/E ratio when they want to know if the share price accurately reflects the projected EPS. The calculation and formula used for this process follow:
The multiples of gross sales vary based on the business, sales predictability from year to year, etc. In general, a business starts with the multiplier and adjusts depending on industry specifics. For instance, the multiplier might be three times sales. But if the company has seen steady and robust growth in the past few years, it may boost the multiplier to 3.5 or more.
Factors that impact business value
Several factors influence the value of privately-owned companies. They include:
- The overall size of the company
- Projected cash flow and revenue
- Quality of business
- Cyclical market forces
- Industry trends
- Cost of and availability of capital in the marketplace
A growing company that can demonstrate an upward cash flow trend in customer acquisition and retention and increasing market share is more appealing to buyers than one that shows little growth.
Size also plays a big part in determining value as those who want to buy a business assume that smaller companies have greater risks than larger ones. A firm that achieves at least $10 million in gross revenue while maintaining greater margins or benchmark is seen as a better opportunity than one that generates less.
External aspects like terrorism, disease outbreaks, relentless competition, and so on can also influence the way you sell your business. As an example, the 9/11 events saw an increase in the value of security and anti-terrorism businesses. On the other hand, the Coronavirus pandemic has impacted the real estate and other sectors because of less availability of capital in the marketplace.
How much should you sell your business for?
In the end, the price of your business will depend on its worth, and the various valuation methods that we’ve discussed above can help you calculate the right price. You may have a hard time tagging a price on a business that you’ve invested so much time and effort in, but the asset valuations, multiples of earnings, discounted cash flows and revenue will help you come up with an amount that’s fair to you and the prospective buyer.