Before You Sell Your Company, Conduct a Business Valuation
If you’re preparing to sell your business, you'll first need to know how much your company is worth by conducting a business valuation. It will give you, your investors and potential buyers a good idea of what your business’s value is by looking at both tangible assets like real estate and cash, as well as intangible assets like intellectual property. It's always good to stay prepared by conducting a business valuation at least once per year.
The following are a few business valuation methods used by businesses to determine their worth. Use these to help you get the best deal.
Asset Business Valuation
Asset valuation measures the worth of your assets, such as inventory, equipment, and real estate. Asset valuation works best if you don't have a profitable business and are looking to liquidate. While this is a fairly simple and popular method of business valuation used by asset-based small businesses, experts warn that it does not accurately reflect the total value of your company.
If a company has $500,000 in assets such as computers, for example, the worth of the business is not automatically $500,000. A business valuation should account for what the companies do with those computers to create revenue and profits.
Asset valuation also does not measure intangibles, such as the goodwill of a company, according to Stan Feldman, chairman of Axiom Valuation Solutions and a finance professor at Bentley College.
The goodwill of a company could include a loyal customer base or a solid relationship with suppliers. An appraiser can help integrate your company's goodwill into a business valuation.
Market Business Valuation
Also called the rule of thumb or market multiplier method, this determines the worth of your business based on a multiplier set by your industry.
For example, the benchmark for valuing companies in your industry may be three times sales. Therefore, you could theoretically value your company at three times its revenue. This method relies on industry averages, however, and may not reflect the true value of your small business.
Earnings Business Valuation
This is also called income-based business valuation or the capitalization of earnings method. Earnings valuation determines the worth of your company based on historic earnings. This method works well for valuing companies with strong intangible assets because it only calculates earnings and takes into account the risks of buying your business. It does not distinguish between the worth of tangible and intangible assets. Earnings valuation cannot predict future earnings as well as discounted cash flow, however.
Discounted Cash Flow
Discounted cash flow is a complicated method that projects future earnings. It is used to estimate the future cash flows of your company, excluding capital expenditures and increases in working capital, or the money needed to run the business.
Feldman prefers this method for companies that have historically been profitable, citing academic research that indicates it is the most valuable method for determining the worth of a company.
A financial analyst or account should be used to determine future earnings.
Tips Before Conducting a Business Valuation
- Value is relative. Just as your business is unique, so too is its structure and value: Your cash flow may be strong, but your earnings may be below industry average. Or perhaps you have valuable intangible assets, such as a loyal customer base or patents. The process can be subjective and influenced by factors that a seller can't control, such as industry forecasts and the economy.
- Get started early. You will want to conduct a business valuation years before a sale, particularly if you want to increase earnings or cash flow in order to raise the asking price. You'll need to show the last three years of financial statements to a prospective buyer, so valuing your company four or five years prior to a sale is a good strategy if you want to increase its value prior to eventual sale.
- Do your homework. Because business valuations are often complicated and different methods are preferred in different industries, it's best to research valuations thoroughly and employ financial advisers—particularly business valuation specialists—before proceeding with a sale. To find an appraiser, check with other small business owners, including competitors who may want to buy your business or the American Society of Appraisers.