Since Entrepreneurs put a lot of sweat, toil & dollars into building a business, there is all kinds of resources available on GROWING a business. But what about when it is time to cash out? How does one determine the value of a business to determine an asking price to sell?
Here are two common methods that can be used to estimate the value of a business:
1) Multiple Of One Year Sales.
Under this method, the value of the business is based upon one year’s gross sales.In rough terms, if a business has gross revenues of $500K, then the business is worth $500K.
The value may have a â€˜multipleâ€™ applied to it to reflect market conditions and reflect either a discount or a premium. A common range would be 75% to 140% of gross.
Hence a business with gross revenues of $500K could possibly be worth $375K to $700K.
2) Average Of One Year Net Income.
Under this method, the value of the business is based an average of several years of one year’s net income. Then a multiple based on the number of years averaged is applied.
This formula is easier than how it reads!
Say a business has net income of $30K in Year A, $80K in Year B, & $115K in Year C, with a 3 year average of $75. A multiple of three years for the number of years averaged is then applied.
Hence a business with a three year average of $75 net income is worth approximately $225K.
Based on the examples above, the same business could be worth between $225,000 to $700,000!
If one were to average the two methods to generate a ˜ballpark”, the business is worth around $463,000.
Valuating a business is highly subjective; it’s as much an art as it is a science.
There are other empirical methods that can be used to analyze the value of a business. Frankly, a businessperson thinking of selling should be prepared to use them.
Part of the art involves looking at these estimated values and determining their worthiness and adjusting the value accordingly. One must use subjective concepts as to condition of hard assets sold, ability to transfer the goodwill of the seller to the buyer and a need for a workforce or know-how in place.
If one wants a hard estimate of what the value of a business is, get help from someone who understands the true art & science of business valuations.
Be aware of overly-glossy presentations. That may disguise a glib or banal valuation.
The blogger, John J. Kasperek, EA, has enjoyed helping many businesses throughout 25 years of practice.