How to Determine the Worth of Your Business
Though there is not a hard and fast rule for determining your businesses’ worth, there are several guidelines and various techniques that could assist both you and the buyer to determine how much the business is worth. We will look at the reasons why a business many need to be valued and the various techniques that can be used to value a business in this article.
Here are some of the more common reasons why a business would need to be valued:
To Sell the Business
This is probably the most common reason why a business would need to be valued. If the owner wishes to sell the business then the business must be valued in order to know exactly how much it is worth. In other words, the business must be valued to come up with a sales price for the business.
To Procure Financing
If a business is wishing to seek outside funds, it can be done through a variety of ways. It can be done through borrowing money from a bank, taking out a loan from a lending institution, or by seeking an investor or partner. In any of these situations the business needs to be valued so that the person loaning money or investing in the business truly understands what they are investing into.
An Owner Wishes To Exit
A business would need to be valued if an owner or shareholder of the business wishes to sell his/her share of the business. If this is the case then all parties involved need to know exactly how much their share is worth and so they would perform a business valuation. Then, based on the valuation they would determine how much the owner’s portion is worth.
For Insurance or Estate Planning Purposes
If you need to insure the business or you are needing to set up an estate plan you will need to determine the business's worth to set these up properly.
To Merge With an Existing Business
This is very similar to valuing the business in order to sell it. Both businesses who are merging need to know how much each business is worth so that its various shareholders and investors know how much of an ownership stake they should have in the newly formed company.
Now that we know why a business might want to sell, let’s look at the various methods for valuing a business. As mentioned earlier, there are numerous methods for evaluating a business and each method depends on many different factors. Below are some of the more common valuation methods for determining the worth of the business.
Adjusted Book Value
The book value is the value of the assets and liabilities that have been adjusted to their fair market value. You would then subtract the liabilities from the assets to see how much the business is worth.
This is the value of all assets of the business. Assets would include items like facilities, inventory, equipment, supplies, accounts receivable, and cash.
Capitalized Earnings Approach
This method of valuing a company is calculated by taking EBITDA (Earnings before interest, taxes, depreciation, and amortization) and dividing by what is called a capitalization rate. The capitalization rate is what the investor, or buyer, would like as a rate of return.
This method is based on determining how much money a lender would loan the business based on the current cash flow that the business provides.
The Debt Assumption method is based on the most debt a business could incur while still being able to meet its obligations using its own cash flow.
Discounted Cash Flow
This is a method of valuing a company using the “time value of money” concept. The “time value of money” concept simply means that cash received today is worth more than cash received tomorrow or at some point in the future. The basic idea is that projected earnings must be discounted to account for inflation.
This method is based on the cash flow that the business provides and multiplying it by a certain number. For example, if the industry standard states that a business is worth three times cash flow then you would simply take a year’s worth of cash flow (essentially profit) and multiply by three.
This method valuates a business based on the anticipated income that the business would be estimated to provide in the future.
This method is simply valuing a business based on the total of all intangible assets the company can provide. For example, if a company does not have a lot of assets, such as service based businesses, but rather has a large lucrative customer base, then this customer base would be considered an intangible asset.
This method of valuation is based on the industry that the business is in. This method takes the gross sales of a business and multiplies it by a set industry percentage. For example, a set percentage for lawn care businesses could be 30%. By using this method, you would take 30% of the annual gross sales to come up with the valuation price.
As you can see, there are many different methods for coming up with a business valuation. There is no right or wrong method. The selling price of a business is essentially what the seller and the buyer agree the business is worth. These methods listed here however, are the more common ways businesses are valued. It is advisable to seek the guidance of a business broker. They will help you with appraising the business as well as listing and selling the business.