Most often, business owners do a business valuation because they're considering selling their business and want to set the best asking price. It's not difficult to learn how to value a small business. Small business valuations are also critical if you're converting to S-corporation status or want to include your business in your estate planning. Whatever your reason is for valuing your business, it's strongly recommended that you work closely with your accountant and/or hire a professional business appraiser.
Business Appraisers
Business appraisers are your most valuable resource when it comes to small business valuation. There are several business valuation models that are used to determine the value of your business and each of them takes a variety of factors into account.
While it's possible to value your business on your own, hiring a professional to appraise your business is the best way to ensure its true value. If you're doing a business valuation in preparation to sell, buyers may take your asking price more seriously than if you set it on your own.
Working with a business appraiser also helps protect you from overvaluing your business-and decreasing your chances of selling-or undervaluing your business to the point where you lose money on the deal.
Business Assets Valuation Model
Asset-based valuation models attempt to value your business based on the cost to replace your physical assets in the same or similar condition. If your business' earnings don't exceed the value of those assets, your business may only be worth the value of its assets.
In this case, at minimum, you'll want the value of your business to reflect the dollar amount you'd receive if you were to sell your physical assets. Two ways of determining what your assets are worth are their book value and liquidation value.
Book value is not an indication of the current market value of your assets. Rather, it looks at what your assets cost and how much they've depreciated in value since purchase. The liquidation value usually refers to the dollar amount you'd get if you were to sell your assets quickly minus your outstanding debts (i.e., your company's net worth).
If your business' earnings are worth more than the value of your physical assets, the asset-based model isn't the best one for you or your business.
Income and Earnings Valuation Model
Most businesses structure their finances to minimize tax obligations, thus financial statements don't provide a true picture of the business' profitability.
In some cases, you may need to remove line items like your salary and personal expenses you run through the business; in others, you'll need to include them as part of your discretionary earnings. Work with your accountant to recast your financials to reflect your actual profitability to serve as the baseline for valuing your business. What you need to do depends on which income or earnings valuation model you're using-another good reason to hire an experienced appraiser to do your business valuation for you.
Income and earnings valuation models may use one or more rates to convert a portion of your business earnings to determine you're the sale value of your business-capitalization rate and discount rate are two of the most common rates used. The rate that's used depends on how your earnings are being taken into account (e.g., pre-tax, after-tax or cash flow).
In simpler terms, you're essentially valuing your business based on its debt-paying ability or capitalization of cash flow. In the first scenario, depreciation and capital improvements are deducted from net after-tax earnings and any increases working capital. Buyers look at this figure then add the percentage of return they'd like to get on the investment to help calculate how long it would take then repay any loans they take out to purchase the business, minus the down payment. Typically, buyers will evaluate this for a five-year period.
In the second scenario, you start with annual earnings before interest and taxes, which the buyer would divide by their desired return on investment. So, if your earnings before interest and taxes are $175,000 and the buyer's looking for 20% return on investment, the value would be $87,500.
If the proper rate isn't matched to the earnings type, your business value won't be correct. If the conversions are done correctly however, then each method of conversion should produce about the same value.
Market Condition Valuation Model
The market condition valuation model determines the value of your business by looking at the earnings, sale prices and asset value of businesses like yours that have recently sold as well as industry averages. These figures are then compared to your business' sales, earnings and asset values. The market condition valuation model is usually the quickest way to value your business, but it's not always the most accurate.
 | You are a small business owner and considering whether selling a business is the right choice. Don't fret if you are in the dark about selling a small business. Learning about the initial offer, legal terms and process will help you make the right decisions during this important time in your company. With a little help from your lawyer, accountant and banker, you can successfully sell a small business. |
Deciding to sell your business is never easy. Is it the right time? What will you do next? Will you get the money for your business that you believe its worth? Will it be hard to sell your business? All of these are questions you are probably thinking about. |
Business valuation is not an exact science and depends substantially on the type of business and assets you have. There are many expert business valuators who can help you nail down a value when you're ready to pass over the reins. |
If you are considering selling a business, learn how to value your business so that you can get the right price for your business needs. |
