Business valuation. How much is your Business Worth?
A “Brokers Opinion of Value”
What is a Business Worth (Business Valuation)?
The number one question that all of our clients have when contemplating a sale is, “How much is my business worth?” And the question from buyers is, “How much is that business worth?” Great questions… Please read on for how this calculation is reached.
Determining the Value of a Business
Many things affect the value of a business: Earnings, location, size, competition, growth rates, industry trends, current and accurate books, ease of transfer, time you have to sell, comparables, terms of the sale, leverage, will the key employees stay, AND which business broker you hire.
Business Valuation is a Combination of Several Methods
We use five generally accepted approaches to valuing a business and we are intimately familiar with each one of them. We use these following established methods and approaches when we perform a “Brokers Opinion of Value”.
- Multiple of Discretionary Earnings Approach – Because businesses in what we call the Micro-Middle Market size generally have discretionary expenses not associated with the operation of the business, business brokers use an Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) approach. That formula is: Seller’s Discretionary Earnings = EBITDA + the seller’s Salary + the seller’s Benefits and Perks. This earnings number is multiplied by a “Multiple”. Thus the Multiple of Discretionary Earnings description. Multiples range from 1-6 depending on many factors: Industry type, size of business, perceived risk and other factors.
- Excess Earnings Approach– This method originally appeared in a 1920 US Treasury Appeals and Review Memorandum, ARM 34. It was updated and restated in IRS Revenue Ruling 68-609. The earnings still come from the Seller’s Discretionary Earnings definition, but from there on out it is different. A manager’s salary is left in as an expense and the formula looks for a return on investment of capital equipment and any working capital associated with running the business. Those adjustments boil down to an “Excess Earnings” number. A capitalization rate is applied to that Excess Earnings number to arrive at a value for the business.
- Cash Flow Approach – Often a business in the profitable category reaches its ceiling of transaction value by no longer “cash flowing”. That means that the earnings of the company are not enough to cover a couple of key performance metrics. The company earnings must provide either a Return on Investment OR a new owner’s salary AND be able to service the loan debt that is typically used to acquire the company. If a deal does not Cash Flow, the deal is not bankable and a seller should not consider carrying a note on the sale.
- Done Deal Comparables Approach – These comparables (comps) are actual business transactions that have sold. We have access to multiple databases organized by your industry segment. By analyzing this data for similar transactions, we create a supportable valuation recommendation.
- Underperforming Companies Approach– Profitable is nice, but not always necessary. There is normally still value in underperforming businesses that exceeds the liquidation value of the hard assets for “non-retail” businesses. Underperforming businesses need some tough love however. Most often they need to be acquired by a similar business so overhead can be consolidated and allow them to be profitable again. Transaction terms are key in the value of these types of companies and typically include a combination of asset liquidation and payments tied to continuing revenue streams to maximize the transaction value for the seller.
Want to know what your business is worth?
Here’s what you need to have ready:
- Year to date P&L and Balance Sheet (within 60 days)
- Three years tax returns and three years P&Ls
- List of salaries, benefits and perks going to owners (click for spreadsheet)
- Equipment list, leases and depreciation (if not on tax return)
- Description of facility lease or if building is owned
- Itemization of top 10 clients and percent of total revenues. List of any contracts with those clients.
- Company organizational chart
- Disclosure of any regulatory requirements and/or special licenses (if applicable)
Click here to see a sample of the Broker Opinion Value Agreement