November 02, 2016
How to value your business when selling.
Determine your business' value.A business' value is based on both tangible and intangible factors. Tangible assets are significantly easier to measure.
Your business is worth what someone is prepared to pay for it, and it hinges on several factors:
- Past cash flow, profitability, and the value of assets
- How much profit it's likely to make, balanced by the risks involved
- Hard-to-measure factors such as key business relationships and goodwill that provide added value
Decide on your valuation method.There are a few common methods for determining a business’s value, including:
- Earning valuation
- Asset-based valuation
- Market value
Earning valuation method
The earning valuation method assumes that your business’ true value is in its ability to create wealth in the future. There are two approaches you can use to value your business using this method.
- Capitalizing past earning: Here, an appraiser uses your past earnings to determine an expected level of cash flow. Unusual revenue and expenses are taken into account, and then a capitalization factor is multiplied against the expected normal cash flows. The capitalization factor reflects the rate of return an average buyer would expect, and it also measures the risk of expected earnings not being achieved.
- Discounted future earnings: Discounted future earnings are based on predicted future earnings rather than past earnings. In this approach, the appraiser would take an average of the trend of predicted future earnings to come up with an estimate, but not a promise, of future profitability.
An asset-based valuation takes into account all of the assets in your business.
Going concern: A going concern asset-based valuation will list your business net balance sheet value of all its assets and subtract the value of all its liabilities.
- Liquidation: A liquidation asset-based valuation establishes the net cash that will be obtained if all of your business assets are sold and its liabilities paid.
A market value method aims to establish a value based on what other similar businesses have been sold for recently.
It's possible to reach different results with these valuation methods, so it’s best to get your business appraised using more than one method.
Calculate your business goodwill.Goodwill is based on a combination of intangible factors that give your business greater value, such as:
- Relationships with customers and suppliers: a future owner has an advantage if a loyal client and supply base has already been built up
- Intellectual property (IP): human creativity and innovation like a patent or a copyright
- Location: one of the keys to a successful business is having a great location
- Liquidity: how quickly your business can get cash to meet its obligations
- Brand equity: how well consumers know your brand and how well respected it is by your customers
Establish your assets' resale value.Calculate the resale value of your business fixed assets such as real estate, vehicles, office equipment and machinery. For some of these assets such as real estate, the value may increase over time. For others, like work vehicles, the value will decrease as time passes.
To ensure the values of your fixed assets are accurate, use depreciation to project how their value will decrease over time.
Examine the market.Whether you use the market value method or not, you should take a look at the market when preparing to sell your business. This can help you get a sense of how similar businesses are performing and the prices they're selling for when put up for sale.
Who do you want to sell to?
Have an idea of the kind of buyer you would want to take over your business. It's important to understand what about your business is valuable to that type of buyer, so that you can try to maximize its worth.
To come up with a representative value of your business, take into consideration your method of valuation, the goodwill in your business, the resale value of your fixed assets and the value of similar businesses selling on the market.