What’s My Business Really Worth? 12 Questions (And Answers) To Solving Your Business Valuation Mystery Monday, November 05, 2018
Have you watched shows such as Shark Tank or The Profit and wondered how Kevin O’Leary or Marcus Lemonis calculate business valuation? Unfortunately, reality television shows aren’t the best platform for learning how to value a small business (or a company of any size). That’s why we surveyed our business valuation experts, captured the 12 most frequently asked questions, and provided answers that can offer the guidance you need.
Question 1: Why do I need to understand business valuation?
The above question is a great conversation starter! Maybe you’re a business owner thinking about how to sell your business. Or, you might be seeking a loan for your business from a bank. Alternatively, you could be an investor interested in valuing a company for acquisition. Perhaps you’re just curious about the answer to the question, “How are businesses valued?”
Whatever the circumstance, to determine the answer to, “How much is a business worth?,” you must go through the meticulous process of business valuation. Before you make a run toward the exit or hide under a pile of blankets, we’ll try to make it easy for you to understand!
Much like a commercial real estate appraisal, there is an underlying economic analysis for business valuation. Entrepreneurs can determine worth via several approaches (or methods) available. These approaches to valuing a business are discussed in more detail, below; however, they are each based on specific criteria, from industry performance to market climate.
Now that we understand the “why,” it is imperative that you understand the “what” and “how.” As such, our experts at The Robert Weiler Company have put together this business valuation ‘questions and answers’ overview to offer more clarity behind the business appraisal process. By the time you reach the end, we’re confident that you’ll have a better understanding of what a business valuation is, the critical factors of a business appraisal, and the process that goes into estimating the actual value of a business.
Question 2: What is business valuation?
Business valuation is a set of steps used to estimate what your business (or a company you are looking to purchase) is worth. The process, however, is much less straightforward than the definition. So, how are businesses valued? To properly evaluate a company, you must examine the historical earnings and financial outlook that will go into the formulation of the particular business valuation. Elements such as assets (both tangible and intangible), current market conditions, and the circumstances of the business (i.e., the reason behind the sale) will be critical to the overall calculation.
Question 3: What are the most commonly used business valuation methods?
As with property value in commercial real estate appraisals, a business’s worth can be determined in several ways.
There are three common approaches to answering, “how much is my business worth to sell?” They are: (1) the asset-based approach; (2) the earning value approach; and (3) the market value approach. The key is to apply the optimal approach for each business, based on the business’s capital structure, management, prospective future earnings, and market value.
1.) The asset-based approach.
This method focuses on investments made in the business, and there are two tactics to take with this option.
(a) A going-concern asset-based approach. Here, buyers are trying to determine commercial valuation according to whether it is worth the investment to purchase the existing business, factoring in all assets and liabilities. Or, the person may find that it makes more sense to start a new business from the ground up. In this specific approach, liabilities are subtracted from the total value of all assets to determine the business worth.
(b) A liquidation asset-based approach. In a business liquidation scenario, you must determine the amount of money left after selling all assets and paying all liabilities.
2.) The earning value approach.
Discovering the earning value involves consideration of the return on investment (ROI). As such, you must assess the potential level of income that the business can generate in the future.
(a) Capitalizing past earnings. The appraiser must refer to the company’s past net earnings performance and process that figure by capitalizing this number to a present value. This method will predict the ROI for the purchaser, while also offering the level of risk that the ROI will be achieved.
(b) Discounted future earnings. If the business does not have a long history, this becomes the preferred valuation method; it relies on projected earnings that are discounted, to obtain a present value of future revenues.
3.) The market value approach.
Also known as the sales comparison approach, this method assesses recently sold comparable businesses, as well as asking prices on currently listed businesses. By considering the value of related businesses in your community or region, an appraiser can provide the estimated worth of your company. It should be noted that business valuation under this method is important if there are several other similar businesses available for this type of comparison.
Question 4: Why are there different methods of business valuation?
How to value a small business or large enterprise is viewed differently by potential buyers depending on their current situations and standpoints. For example, the fact that a firm holds such an excellent reputation and prominent position in the community might make it valuable for a buyer within that community. On the other hand, a buyer with no community ties may look strictly at the ROI or future earnings of the company.
Also, as stated previously, finding the real value of a business is not a one-size-fits-all approach. Different methods can indicate varying monetary values, depending on which (or which combination) of the aforementioned three business valuation approaches you use.
Question 5: Why should I consider business valuation for my entity?
Even if you do not yet want to know how to sell your business, there are still several reasons why you should obtain business valuation services. The most important reason? Life’s unpredictability. If an unforeseen circumstance arises and you decide to sell, having a credible business valuation is vital in determining the asking price and aiding in negotiations. Other reasons may include:
- Unforeseen health conditions
- Planning for retirement
- The need for financial assistance, such as debt financing, bankruptcy, or financing for expansion
- Internal use, such as employees or others who are looking to buy shares in the business
- Litigation purposes, such as marital dissolutions or shareholder disputes
Question 6: What is the general business valuation formula?
While the nature, assets, and current circumstances of the business weigh heavily on the overall result of the business valuation, there is a base mathematical formula used to calculate the value.
Step 1. Calculate your earnings. Sometimes referred to as Seller’s Discretionary Earnings, or SDE, this number is principally used to show your business’s earning potential with a new owner. This number is calculated pre-tax and excludes expenses that would not transfer to the new owner. SDE will not include your compensation, bonuses, or any other one-time or non-applicable expenses.
Step 2. Choose your multiplier. The multiplier is where business valuation becomes subjective. Depending on a multitude of factors, buyers will opt to pay generally between one and four times the amount calculated in Step 1. So, how do you choose if you want that to be 1x, 2x, or any other amount? Take a look at the detailed items that are specific to your business, such as:
- Industry level of establishment and necessity
- Level of desirability of the business location
- Market climate and risk
- Size and stability of the company
- Tangible and intangible assets
- Owner risk, in the sense that the business cannot function without you, specifically
- Real estate lease agreement, as far as the length of time left on the lease, and whether the new owner will have to negotiate new terms
Step 3. Add in both tangible and intangible assets. We touch on this more in Question 7, but assets are things that add value to your total. Tangible assets are physical goods, and intangible assets are non-physical.
Step 4. Subtract any liabilities. Subtractions apply if the business is in debt, or if there are future expenses that need to be factored in when calculating the overall value.
Question 7: How do I determine which commercial valuation method(s) will work best for my business?
Most times, the reason for performing a business appraisal will determine the best method. There is no “right” or “single” answer when it comes to valuing a business. Since the value of the company is impacted by the goals and financial position of the prospective buyer, one method, or a combination of ways, can be used to obtain the value. Also, as with a commercial property appraisal, hiring an experienced professional to assist in your endeavor will ensure that you make an intelligent decision for your business.
Question 8: What are tangible vs. intangible assets in business valuation?
Assets are investments made that add value to the business. There is one significant difference in tangible vs. intangible assets, and that lies solely on whether or not they physically exist. Scratching your head? Let’s unpack the definition of tangible assets and intangible assets.
Tangible assets are physical items that have value if they were sold. Assets included in this category are items such as:
- Real estate, such as buildings owned
- Machinery, equipment, fixtures, furniture, trucks, and cars
- Securities and cash
Intangible assets, on the other hand, are non-physical things that also add value, along with the sale of the business. Examples of intangible assets include:
- A positive business reputation
- Level of value of the business’s customers
- Any well-known business trademarks or branding
- Industry experience
- Established relationships with suppliers, buyers, or partners
- Copyrights and patents
- Little to no owner risk (meaning that the business can operate free of the current owner)
The circumstances behind the sale of the business may also fall into the intangible assets category. For example, if the company is a successful startup, a voluntary sale scenario with a buyer who recognizes increased future profit will add value to the firm. On the flip side, if the current circumstance is a forced sale, this intangible asset can be a liability that factors into business valuation.
Question 9: How can a business owner prepare for a favorable business valuation?
Did you know you can prepare for your business valuation, and help the process move smoothly and efficiently? While the preparation for a positive valuation technically starts at the beginning of the business’s existence, it carries on with each passing day.
Refer to your business plan. Before starting your business, you likely created a detailed business plan that outlined your short- and long-term goals. By referring to this planning document, and updating or adding to it as necessary, you’re helping yourself stay on track. Adhering to your plan and goals will allow you to prove the success of your business to potential buyers or investors in the future.
Keep your books up-to-date. Most commercial business valuations will consider profit and loss records for the previous few years, if available. You will also be asked to provide balance sheets, tax returns, and copies of any budgets and future financial projections. Make sure your books are organized and detailed, showing all income and expenses for each year.
Reduce any risk of liabilities. Reducing liability can be done several ways:
- Diversifying your customer portfolio
- Having practical and concrete processes in place
- Safely storing confidential information like financial records, employee information, and customer information
These are just a few examples that will show that your business is a reliable establishment and encourage confidence in your company.
Pay off debts. Paying off any outstanding debt is partnered with reducing liability risk. If the sale is voluntary, it will prove beneficial to pay off any financial debts before the business valuation and eventual sale.
Question 10: What else can affect or vary the business valuation process?
In addition to the items listed above, there are other scenarios and essential pieces of information about which you should be aware.
Non-competition clauses. Commonly included in the business valuation process is a non-competition clause. The main goal with a “non-compete” provision is to prevent the seller from opening a new business to rival your company in the same geographical location. To further complicate the issue, the seller may want to continue working in the same trade elsewhere, or under a different circumstance, which has the potential to prove difficult for the buyer. These clauses usually have to be worked out with the assistance of an attorney, to ensure that they are legally correct.
Sole proprietorships. Business valuation for a sole proprietorship can become complicated in any of the approaches described above.
- With an asset-based approach, the sole proprietor must identify business assets vs. personal assets. This becomes a detailed process since many sole proprietors will use the same tools or equipment at home as they would on a job.
- With an earning value approach, many sole proprietors have built trustworthy personal relationships with clients. These relationships can mean that any future earnings will decrease if the clients are unwilling to work with a new owner.
- With the market value approach, locating another business with public sale information that is similar to the sole proprietorship may prove challenging.
For accuracy, business valuators may use a combination of valuation methods when looking at a sole proprietorship.
Franchises. Franchised businesses typically do not follow the same procedure when it comes to valuing a private business. This is because the owner is subject to the franchise contract, which tends to influence how the business is sold. Often, a franchise contract may also provide guidelines on how or where to obtain the business valuation.
Question 11: How much is my business worth to sell?
When estimating how to value a business to sell, there are two central questions you must answer: “How much is my business worth?” and “How much can I sell my business for?”
You may not even be interested in selling your company at this time; however, value is a great measure of success. You’ve worked hard to build your business! Aren’t you a bit curious to know how much it’s worth? Keep in mind that what you feel your business is worth may differ from the opinion of an investor looking to buy your business.
Small business valuation can be complex with many factors involved. That’s why we’ve touched on several factors, formulas, and methods throughout this business valuation ‘questions and answers’ overview. However, if you’re just looking for a rough idea as to how to value a small business, start here:
- First, consider how profitable your business is. (Subtract expenses from revenue.)
- Then, factor in items such as taxes, cash flow, and estimated future earnings.
- Finally, project future growth.
And, don’t forget to evaluate risks and challenges that both your business and industry may face down the road.
Or, get a simple company valuation with this free calculator offered by money.cnn.com. The calculation is partially based on earnings before interest, taxes, depreciation, and amortization (or EBITDA). In traditional private equity investments or mergers and acquisitions situations, EBITDA becomes an important earnings metric, as it’s capital structure neutral; thus, not affected by finance decisions and non-cash expenses.
Question 12: Where can I find certified business valuation companies in Ohio?
If you need a certified business valuation analyst in the Columbus, Ohio area (or throughout the state of Ohio), look no further than our team at The Robert Weiler Company! For 80 years, investors have turned to us for expertise in our commercial real estate appraisal services, only to find out about our ability to value businesses, too.
As a CRE firm that’s been successful through three generations of family leadership, we are passionate about our local business community. Our full-service business valuation services offer decades of experience in the Ohio market. We will treat your business with the same care we would if it were our own.
Time to contact a certified business appraiser! Uncover the true value of your company via a thorough and accurate process performed by The Robert Weiler Company. As a family-owned business for 80 years, we understand the hard work you’ve placed on building your livelihood. Let us show you the worth of your entrepreneurial pursuit via our business valuation solution; contact one of our business appraisers today at 614-245-2225.