How to Calculate What Your Business is Worth

Bill Long
Bill Long

What do owners typically think their business is worth?

Most privately held business owner’s view their business value as a multiple of cash flow, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or multiple of Benefit to Owner. Business owners typically hear multiples in the range of 3 to 7 times one of these cash flow metrics as a means for business valuation. For example, a company with $3,000,000 in EBITDA at a multiple of 5 would be worth $15,000,000, plus the value of real estate and some other assets. A lot of other factors will go in to the offer price that will typically result in the value of the business being less than the owner anticipates. You should consider all of the factors that create value for your business long before you ever make the decision to sell it. This will help establish a much better price at the time of your sale.

How do valuation experts look at your business?

A full business valuation will consider far more than just cash flow and will look in depth at an extensive list of items that impact the true value of your business which typically will include the following:

  • Type of business – This would include professional, service, retail, wholesale/distribution, manufacturing, construction, agriculture, bank/financial service, medical and others.
  • Proprietary content of the business – Highly proprietary, moderate, or low.
  • Industry life cycle – mature industry, growing industry, declining industry.
  • Industry stability – Stable, unstable, highly volatile.
  • Strength of the business in its market – strong & growing, stable, declining.
  • Overall size of the business market you are in.
  • Relative size of your business to the market – One of the largest members of the market, in the top 20% of the market, or some other smaller size.
  • Business Risk – Percentage of the concentration of sales in the top 5 customers. The higher this percentage, the riskier the business and the lower the value. If this number is over 70%, you need to diversify your customer base.
  • Relative quality of your goods and services to others in your market.
  • Inventory Turnover Ratio.
  • Product differentiation – Highly unique, somewhat unique, no differentiation.
  • Market area – Local, regional, national, international.
  • Number of employees and your employee turnover rate. Remember – high turnover is always costlier then you first think.
  • The number of highly skilled employees needed to run your business.
  • Whether your business is unionized or not. Believe it or not, in some cases, being unionized can be a positive and not a negative. It depends on your business and what benefits unionized employees brings to the business.
  • Management depth and quality, excluding the current owners. This will be discussed in more depth later.
  • Facility quality, productivity, and throughput.
  • Ease of entry into your market – difficult or easy.
  • Quality of management information systems and documented business processes.
  • Are your business processes auditable?
  • Buy-sell agreements between current owners.
  • Non-compete agreements with key employees.
  • Current litigation.
  • Patents, trademarks, copy rights or other intangibles your business owns.
  • Quality and type of board of directors and frequency of meetings. Many privately held businesses have a board of advisors rather than a board of directors.

As you can see from the above list, the value of a business includes far more than just a simple multiple of cash flow. The answer to each of the items above will impact the overall value of your business either positively or negatively. Anyone of these items can cause the value to decline or increase.

What DO buyers really look for?

  • Ability to run as a standalone business without the owner – Remember the item above concerning the quality of management excluding the owners? This is a key component of creating business value. If the ability of the business to maintain current revenue is largely dependent on the owner driving the business, then the only thing you really have for sale is a customer list that will have nothing resembling the value of the business cash flow times a multiple. Ask yourself a very difficult question – If you dropped dead tomorrow, can your business continue to grow and prosper with the current management and staff you have in place? If you cannot, without any hesitation, say yes, then you have a very significant problem that is adversely impacting the value of your business. Ask yourself the reverse question, if you sold your company, how long will the buyers have to keep you to support the business? If the answer is greater than 6 months, you are too vested in your business and do not have the correct management in place.
  • Process, procedures and policies – A well run business of almost any size should have documented business processes, daily operational procedures, and written policies that support both the business processes and procedures. This does not need to be overly complicated, in fact simple and easy to understand is better than big binders that never get read. A potential purchaser will find paying a higher multiple easier to justify if these are well documented and a transaction audit shows that they are being followed by all levels of employees.
  • Growth rate – If your company is showing consistent growth in revenue and income over the last 3 to 5 years you can expect to receive a better offer at the time of a sale versus a company that is showing stable but flat sales or worse yet declining sales. If your company is not growing you should develop a plan to reverse this trend immediately starting with improving sales growth.

What do you do to improve the value of your business?

  • Start now with a plan. Do not wait. Now is the best time to start putting a plan in place to increase the value of your business when you are ready to sell. Do this even if your time horizon is out 10 years or more.
  • Set a base line. Consider having your business professionally valued by an AICPA certified valuation expert. Depending on the size and complexity of your business, you may be able to get a professionally prepared valuation completed for $5,000 or less. This will give you a baseline to determine if the changes you are making are helping increase value. Consider doing this again in 3 years to validate you are making progress improving your business’s value.
  • Improve your management. If you cannot affirmatively answer the question of whether or not your business can run without you, start now to determine what management changes must be made to positively resolve this major issue.
  • Build a support team. If you do not have a board of directors, consider setting up a board of advisors to help you with resolving all of these issues. Have your board made up of your corporate attorney, your tax advisor and several trusted business owners, both in and out of your industry, that do not compete with you. Consider having quarterly board meetings with a formal report to the board showing what improvements have been made since the last meeting and what needs to be completed over the next quarter. This will help hold you accountable for moving forward and solving problems at the company level. I have clients that insist this has been the single biggest driver that helped them improve their businesses.
  • Contract with skilled consultants. Consider hiring professional help to document your current business processes, improve them if necessary and set up key performance indicators (KPIs) to evaluate your business daily, weekly and monthly. Any of Nperspective’s partners would be pleased to help you with this. We have established relationships with area bankers, accounting firms, law firms, human resource managers and other professionals that we can recommend to you to on an as-needed basis to improve the operations and the value of your business.

To obtain the value that you expect for your business, it is important to invest the time to get it ready to sell. These simple steps will help you before you want to consider selling your business and will help you obtain the valuation you deserve for all your hard work when the time to sell arrives.

Even if you are not selling, if you cannot answer these questions favorably, it means that some level of improvement to your business is needed now. A well-run business is ready to be sold at any time, and you never know when that opportunity may arise.

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