How Much is My Business Worth?
How much is my business worth and what is my business valuation? No question is more important when planning to move on from your business. Be that as it may, few answers are more complicated than determining your business valuation. As a matter of fact, there are entire textbooks written on this exact subject.
Most things of great value have some industry standard for determining value. Real estate has comps. Vehicles have the Kelley Blue Book. Unlike real estate and vehicles, there is no one-size-fits-all business valuation formula for small and mid-sized businesses. For this reason, here is a high-level summary of how business market value is determined.
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Why Do Businesses Have Value?
To start, it is important to understand why a business has value. Business value relates directly to the income the business creates for its owner. In other words, the more income a business produces, the more valuable a business.
Risk also plays a role in business value. The riskier, or more uncertain, a future business income is, the less valuable it is. For example, Amazon creates substantial income for its owners and its future income is very certain. Consequently, Amazon is one of the most valuable businesses on the planet
Lower Risk = More Value
Predictable Income = More Value
Overall, the majority of American business are much, much smaller than Amazon. But, they still provide income, and because they provide income, they have value. To find how much value, we need to consider a number of factors. By and large, the majority of those factors simplify into income and risk. Income is mostly objective (like math or science) while risk is more subjective (like art).
Business Valuation is Part Science
Business school teaches that a business’s primary purpose it to create shareholder (owner) wealth. With publicly traded companies, great emphasis is put on showing how a business is achieving this purpose. Corporation frequently publish their financials and issue shareholder reports to reassure shareholders of their wealth.
Privately held businesses serve the same purpose, but in a different way. Small and private business ‘shareholders’ are often only one or two people. To maximize their wealth, they minimize their biggest expenses–taxes. Therefore, business owners hire and pay accountants and CPAs to help them minimize their taxes. This is where the science comes in.
As business valuers, our job is to go through the financials and interpret what they mean. We then calculate how much income the business really produces. This process involves adding back one-time, non-required, and personal expenses paid by the business. It also involves ‘standardizing’ the business. By finding expenses that would or wouldn’t be included under new ownership, we find true, objective business income.
After we translate the ‘accountant speak’, we make sense of the business income. The science of determining value is really about knowing what questions to ask. We ask the right questions, so it’s possible to understand the math. Any opinion of business value will include this science element. Where most valuations come up short is what we call the ‘art’.
Business Valuation is Part Art
After you work with a few businesses, you come to a realization. No business is the same. Every business has different procedures in place. Each business has its own unique employees and customers. Suppliers and vendors are different. Some businesses have family members working for it and some don’t. Other businesses have key employees who are crucial to its success and others do not. Some businesses get paid right away and some have to wait 60-90 days. Some of these qualities add value and are attractive to buyers and some are not.
All of the unique attributes listed above create a level of risk. Risk decreases business value. In other words, the art of a small business valuation involves a deep, subjective look at the business to find risk. The riskier the business, the more the value needs to be decreased (or ‘discounted’).
A good business value finder will have a process for this subjective aspect of determining business worth. At Exit Brokers (business brokers in Denver), our process uses the Sellability Assessment (which you can take for free). Whatever the process, it needs to identify the amount of risk within a business. This tells us how big of a discount needs to be applied. We find the market value of a business this way.
The Challenges of Business Valuation
In general, valuing a private business is a difficult process. Because large, public companies have a market place, supply and demand for ownership will dictate value. In this market, information is readily available so buyers make informed decisions.
Alternatively, there is no ‘market place’ for small privately held businesses. Business ownership is illiquid meaning they are not easily converted to cash. These smaller businesses only convert into cash through a private sale to another party. This type of transaction takes months or years to complete. And, information such as sales price is not publicly available for these sales. Lack of information makes decision-making more difficult for a buyer.
Another challenge is there are thousands of business niches in America. It is near impossible to find a business with similar size, similar location, that offers similar products / services. You also need to find one that recently sold and have access to the details of the transaction. These, as well as several others, make determining value difficult.
The Types of Business Valuation
Also it is important to understand the types of valuation. The main three types are: opinion of value, market value determination, and appraisal.
Business Broker Opinion of Value
To start, an opinion of value is often provided by a business broker. These are typically free and completed on the spot. Like many things in life, you get what you pay for. As you can imagine, these are very basic value opinions based on high-level financial information. These will not be certified. They will not include the subjective analysis which is crucial to determining real market value. They rarely provide exit strategy recommendations. Frequently, these valuations are higher than true market value to sway the owner into listing with the broker.
Market Value Determination
Second, is a market value determination. This involves both objective and subjective analysis and are ideal for smaller, privately held businesses. These typically take 1-2 weeks to be completed. Certified professionals complete most market value determinations. This allows objectivity. The end report usually includes exit strategy recommendations to help the owner plan. If a business owner is given accurate information so they make informed planning decisions. These valuations will typically cost between $950 and $3,500.
Formal Business Appraisal
Lastly, a business appraisal is a formal, complex financial report. These are typically best for larger, non-public businesses. They typically take several weeks to complete and will dig deep into the financials of the business. Because of the complexity, these can cost $10,000 or more. Unfortunately, little attention is given to the equally important non-financial aspects of the business. These are completed by certified financial professionals and can be used in formal legal disputes. The drawbacks is these professionals often lack real world business sale experience so they are often theoretical.
How Much Is My Business Worth - Why You Should Know
There are many reasons an owner should know the value of your business. The most important is for planning purposes. Most owners wanting to sell are either looking to retire or move onto something new. Either way, it is important to know how much you’ll walk away with.
If an owner is open to selling in 1 to 4 years, knowing the current business value provides options. With the right guidance, they can maximize the value of a business and grow it substantially over a few years. Simple changes make a big difference to sales price. Certain changes dramatically increase business value while other do not. A business is often a business owner’s biggest asset. Making informed decisions can be worth hundreds of thousands–if not millions of dollars.
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In Conclusion: A Business Valuation Is An Important Planning Tool
Informed people make informed decisions. A business is a large asset–something of great value–and should be treated as such. By examining income and risk, we determine a business’s value.
While not an easy process, a valuation examines the objective and subjective aspects of a business. By doing so, an owner gains realistic expectations of true market value. An owner who is serious about business exit planning should pay for a valuation from an objective third-party.
In summary, the whole process will seem a bit overwhelming, and you should seek professional advice along the way. Planning and having the right advisors makes all the difference in maximizing your business price.