Usually the very first question most owners ask me when selling their business is “What’s it worth?” It’s the 64 thousand dollar question and appropriate to ask, but what a business owner may not understand is that valuing a company can and usually is a complex exercise.
The answer, it depends! I know that’s not the answer anyone what’s to hear, but it’s a fact that until some of the positive and negative factors that affect selling price are known (and addressed) you cannot value a business with any accuracy.
Now, there are many valuation experts that use various methods to value a business and these are reasonable in theory, but at the end of the day a buyer will typically offer a price based on the company’s ability to generate sales, cash flow and/or profits. Further, price is commonly reduced by any negative factors that may lower multiples used in valuation techniques and every company has some; so it’s best to work on eliminating them before you try to sell your business. For example; too many “me to” products, too much customer concentration, one or two products that make up more than 20-25% of sales, no succession plan or replacement for operator and so on Get the idea?
Your business, depending on the industry, can be valued based on annual sales using a multiplier using cash flow of profits (also known as the discounted cash flow model) and this typically requires some recasting of your financial statements for various adjustments that may either increase or decrease cash flow or profits. Then multipliers are applied to the final financial projection product after adjustments. A word of caution, the use of multipliers is not an exact science. I have seen multipliers thrown around like they are wet towels. They are at best subjective. The problem is when a business owners hears a multiplier they right away they take ownership of that number. My advice is to use them as a starting point and go from there in order to keep your sanity.
Finally, businesses are sometimes based on asset values when there is no cash flow or profits. Of course, the business must have tangible hard assets or some form of intellectual product when there is no cash flow of profits. This sometimes occurs when a business owner passes, and there is no one left to run the business and the only way to value it is on assets, value or the company is a start up looking for investors.
It’s important to understand that there is no one method or bullet proof out of the box method for valuing your business. My advice is to find trusted advisors that have been down this road before and rely on them to help you navigate through this process.