One of the first questions we commonly receive from business owners thinking about selling their business is how the value of their business is calculated. There are several methods to value a business and we guide business owners through the most common and generally accepted business valuation practices.
Whether you are looking to sell a business over the next few months or many years down the road, the best way to get started is to understand what your business is worth so you can obtain the highest value when you are ready to sell.
The value of a business is largely determined by two things: What a business owns and what a business earns.
What a Business Owns: Tangible and intangible assets. Tangible assets are the furniture, fixtures, equipment, inventory, and any Real Estate a business owns. Intangible assets include the business trade name, contracts with customers, relationships with vendors and suppliers, client lists, employees, leases, licenses, policies and procedures, recipes, trademarks and patents.
What a Business Earns: Business earnings provide a financial benefit to the owner, generally in the form of profits and a salary. It can also provide the owner with fringe benefits such as health insurance, a company car, or a retirement plan. Interest, depreciation, and amortization is also taken into consideration when determining what a business earns as calculated in establishing a business’s EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
How Value is Calculated
Owner operated businesses with sales of $1 million or less generally sell for 1 to 3 times its annual cash flow benefit to the owner (this is also known as SDE – Seller’s Discretionary Earnings using an adjusted EBITDA model). Each industry is different and there are many variables that can push the value of a business up or down, such as: how long the business has been established; the owner’s day to day involvement; how dependent the business is on the owner; the age and condition of the assets the business owns; barriers of entry into the industry; and the amount of competition and market share.
If the earnings are stable and growing, the value can be towards the higher end. If the earnings are variable or declining, then the value can be on the lower end.
Businesses with sales of $1 million to $10 million may sell for multiples of 3 to 5 times its cash flow benefit. Businesses with sales of more than $10 million often have specific industry criteria, which may be applied to determine the value. At this level, buyers may be paying for market share, rights to patents and processes, additions to product lines, or the benefits of strategic or administrative consolidation. A thorough investigation of the business’s financial information is required to uncover the true earnings capability of the business.
Rules of Thumb
When it comes to valuations, most industries have one or more rules of thumb based on revenue or cash flow performance. However, they can vary widely and, in most cases, do not give an accurate value of a business. Since each business is unique, a particular rule of thumb may be off by as much as 100% or more. A seasoned business broker will be able to determine the most relevant information about a business and use the most up-to-date business reference guides and comp databases to make an informed decision about its value.
Let Horizon Business Brokers help you understand the valuation process and accurately determine the value of your business to help you determine if you can obtain your goals in a sale now or help set yourself up for a better, more profitable sale in the future.
Contact us today for a complimentary consultation to explore how we can help you achieve your business goals!
Dustin Zeher, CBI
Founder and Principal Broker/M&A Advisor
Horizon Business Brokers, LLC
Office: 703-910-7384
Cell: 571-437-5135
dustin@horizonbrokers.com
www.horizonbrokers.com
