Opinions Count When Establishing Business Value
Every business owner wants two questions answered when meeting a Business Broker for the first time:
- After barely exchanging handshakes, “What is my business worth?”
- Shortly thereafter, “How do I protect myself so I don’t get the business back later?”
Unfortunately, the answers aren’t always easy ones. Today, we’ll deal with the first question.
The short answer is, “Your business is only worth what someone is willing to pay you and what you’re willing to accept.” The long answer is a lot more complicated.
One of the most interesting valuation methods I’ve seen was proposed by “John,” a well-known local restaurant operator who, wanting to retire, was interested in selling the eatery that had been in his family for two generations. John absolutely was convinced that his business was worth a certain amount because of the days of the week and the hours he was open. John felt that the value of his business was linked to his being open 12 hours a day, six days a week. He felt his business was worth more by not being open a seventh day. Unfortunately, no consideration was given to the revenues and profitability that could have been generated on the extra day.
Entire books have been written about valuation, and so many variables are involved (and many of them subjective) that different “experts” looking at the same company could formulate different recommendations.
Since the value ultimately will depend on both the buyer and seller agreeing on a price, one of the most effective methods is known as “cash flow”. Start by allowing the seller to paint a picture of his business’ true profitability. Buyers typically are comfortable with this method because, at the end of the day, although they are buying a company, what they really are buying is its cash flow.
With an understanding of a business’ actual cash flow, different multipliers can be applied to determine a fair market range of value for the business. Multipliers vary depending upon the type of business. For example a manufacturing facility likely would have a higher multiplier than a service business. Of course many other factors can affect the multiplier. For example, new products in the pipeline, strong market share and a diversified customer base (i.e. no one customer represents more than 10% of sales) can positively affect the multiplier.
Conversely, out-dated inventory, declining market share and the risk that key personnel could leave the business and disrupt operations could have a negative impact.
You’ll notice that this method contains no mention of assets – furniture, fixtures, equipment and inventory – having a role in the valuation of a business. That’s because while those items contribute to establishing cash flow, they, by themselves, have limited value.
That is a concept that is quite troubling for many business owners and one I’ll discuss in greater detail in the future.
Do you have small business questions you would like answered about this article or others? Please visit www.LibertyBusinessBrokersofOntario.com or call 519-903-7807.
William Sivell is the Owner/Broker of Record for Liberty Business Brokers of Ontario.