Cashing Out ... What Is Your Business REALLY Worth?

Comments (20)


Question: What is your business REALLY worth? Answer: Whatever someone else is willing to pay for it at the time.

That's a true statement as far as it goes but it doesn't take into account that the way you arrive at a value for your business can give you much-needed ammunition when it comes to justifying your asking price and therefore allow you to influence what the prospective purchaser is willing to pay.

Here's a quick primer of the various methodologies commonly used for valuing businesses (for purposes of imminent sale or otherwise):

1.) Asset Valuation

This is used by businesses with predominantly physical assets, especially inventory. Typical businesses that would use this approach are manufacturing and retail. The valuation takes into account the following figures: (a) the fair market value of fixed assets and equipment; (b) the value of leasehold improvements; (c) owner benefit (the seller's discretionary cash for one year - comes from the adjusted income statement); and (d) inventory.

2.) Capitalization of Income Valuation

This is used by businesses with predominantly intangible assets. It places no value on physical assets, only intangibles. Typically used by service businesses. Under this method, various factors are given a weighting of 0-5 with 5 being the most positive score. The average of these factors yields the "capitalization rate" which is then multiplied by the buyer's discretionary cash (75% of the owner benefit defined in 1.) above) to arrive at the market value of the business. The factors to be rated are: (a) owner's reason for selling; (b) length of time the company has been in business; (c) length of time the current owner has owned the business; (d) the degree of risk; (e) profitability; (f) location; (g) growth history; (h) competition; (i) barriers to entry; (j) future industry potential; (k) customer base; and (l) technology.

3.) Capitalized Earnings

This method is based on the rate of return anticipated by the investor. Small businesses are expected to have a rate of return of 20-25%. So, if your small business has expected earnings of $10,000 for the year, its value may be $40,000 - $50,000.

4.) Cash Flow

This method is simply based on how much of a loan the purchaser could get based on the adjusted cash flow of the business. The adjustments to cash flow are for amortization, depreciation and equipment replacement. Obviously, when using this method, the value of the business fluctuates with changing interest rates.

5.) Discounted Cash Flow

This method discounts the business's projected earnings to adjust for real growth, inflation and risk. It calculates the value today (i.e., discounted for time) of the business's future earnings.

6.) Leapfrog Start-up

This is used when the buyer wants to save him or herself the cost, time and effort of ramping up a new business. The buyer estimates what it would have cost to do the startup less what is missing plus a premium for saved time. The more difficult, expensive or time consuming the start-up would otherwise be, the higher the value that will be arrived at using this method.

7.) Excess Earning Method

Similar to the capitalized earnings approach, but the return on assets is separated from other earnings which are deemed "excess" earnings generated. The return on assets is usually determined by industry averages.

8.) Owner Benefit Valuation

This method is based on the seller's discretionary cash flow. It is usually used for businesses whose value comes from its ability to generate cash flow and profit. The formula is to simply multiply the the owner benefit by 2.) 2727.)

9.) Rule of Thumb Methods

These are rough guides based on industry averages. Many industry organizations have developed methods for their particular industries. They are highly unscientific and hardly rigorous but act as a good "gut-check". You certainly wouldn't use them on their own but they can be useful to check that the value you've arrived at using a more scientific approach is in the ballpark.

10.) Tangible Assets (Balance Sheet)

This method is basically a value of the business's current assets and nothing else. Typically used where the business is losing money. This approach will usually be utilized when selling the business is just a matter of getting the best possible price for the equipment, inventory and other assets of the business. A good strategy is to approach other firms in the same business that would have a direct use for such assets.

11.) Multiple of Earnings

A multiple of the cash flow of the business is used to calculate its value.

12.) Value of Specific Intangible Assets

The value of the business is based on how much it would have cost the buyer to generate the intangible asset. Typically used where specific intangible assets that come with the business are highly valuable such as a customer base. Customers with a high likelihood of being retained are valuable in most industries.

The most appropriate valuation method for you depends very much on the nature of your business. If you manufacture widgets, for example, you'll want to use the asset valuation method. If you offer website design services, on the other hand, you'll want to use the capitalization of income method instead. If you're selling a web- based business where the major asset is your high traffic volume and/or list of ezine subscribers, you will probably want to use the value of specific intangible assets method, such as 10 cents per subscriber (or whatever the going rate is).

Is more than one valuation method applicable to your business? If so, calculate the value of your business in accordance with all of them and see which gives the best result (i.e., highest value). Another good approach is to average your calculations to get a reasonable ballpark figure.

Whichever method you choose, understand it inside out so that when the time comes, you can authoritatively justify your asking price to potential buyers. Pulling a figure out of thin air without any substantiation whatsoever is much less impressive than being able to say, with confidence, "I worked with my advisers using a number of different methodologies to value the business. We adopted the value of specific intangibles method because the backbone of the business is our large, loyal ezine subscriber database. We also calculated it on the basis of capitalization of income, which yielded a similar value. I can show you the calculations if it will help you see where the number comes from."

By following this approach you may not necessarily get the value you are after (for this reason, many sellers artificially inflate their asking price so they have room to be negotiated down), but at least you have a solid starting point for negotiations and are much more likely to be able to negotiate a price both buyer and seller are able to live with.

About the Author

Elena Fawkner is editor of A Home-Based Business Online ... practical home business ideas for the work-from-home entrepreneur. http://www.ahbbo.com/mmp/sub.cgi?AHBBO=!FLM

Comments

Tuan T 31.05.2008. 17:02

What are some good financial retirement plans for parents after passing on family business? I am taking over the family business soon (Worth approx. $500,000)

My parents are worried on how they will still sustain financial freedom after passing on their company to me. It is primarily a cash business and I want for them to retire without having to worry about money. They have savings but nothing is in the bank. (Old Asian generation mentality)

I propose treating them like company board members that take a certain percentage from the business, while I keep the rest for expansion opportunities. What will be fair for both sides? Thank you.

Tuan T

Admin 31.05.2008. 17:02

In the U.S. this could part of "estate planning." Even if you are not resident here, might try getting some of the info. As you are aware, there are tricky issues involving money, taxes, emotions....
I commend you for caring about taking care of your parents. "A certain percentage" sounds to me to be fair.

Admin

Digmen1 07.07.2009. 22:02

What equity share for business with 3 partners? I have a business with one partner. We are looking at taking in a third partner. What share should we ask him to provide in terms of cash. The same as we have put in or what we feel the business is worth now ?

Digmen1

Admin 07.07.2009. 22:02

this question is very easy to answer....ask him to contribute as much capital as is proportional to what his profit or take home income would be.

Admin

Crystal V 17.11.2009. 18:45

I want to start a business consulting childcare centers. What is the best marketing? How do I get started? I would like to be a consultant for those just opening a child care center or wanting to open one in the near future. I have 17 years experience in this field, including Director and District Manager. How do I get a website started and market this business? Also, how do I find out if this business is worth getting into in this recession? Thank you!

Crystal V

Admin 17.11.2009. 18:45

people just opening a buisness will be very strapped for cash. will they have enough to hire a consultant?? maybe you should write a book with a ton of good tips in it and make a web site advertising the book and also sell it on ebay. see how it goes. you may then offer consulting if any super rich people open a day care and contact you for more info.
as for web sites contact a computer nerd from the phone book or try homestead.com they are pretty inexpensive and you do it yourself

Admin

Cigar Man 02.06.2008. 16:04

What do you think of my idea to sell rabbits feet for $1.00 each on the streets of Las Vegas? Lots of demand? Cash business?
Amazing at how many of you did not read the question property. I propose to sell lucky rabbits feet, not rabbits!

Cigar Man

Admin 02.06.2008. 16:04

It might be a good idea to get a vendors permit and charge two bucks to include sales tax and pay the tax. They do not look too kindly though on street vendors but it is worth a try. Better than getting arrested for not having a license. People are superstitious and a good luck charm just might be a good idea.

Funny how many idiots here thought you were selling the rabbits.

Admin

JB 14.03.2013. 22:01

What journal entries do I make to account for business expenses paid from a personal accout? I started a small cash-based service business in 2011 as a single-member LLC. While I have kept meticulous records of business income as well as business expenses and properly filed taxes, I have not prepared journal entries or financial statements. As I am now looking to prepare these statements, I realize it may be problematic that we have been paying some business expenses from our personal account. (I am going to correct this issue going forward by using a business debit card linked directly to the business bank account.)

What accounts should I debit and credit to accurately reflect this issue in 2011 and 2012? How should it appear on my financial statements?

JB

Admin 14.03.2013. 22:01

Unless you have a specific need to present prior period financial statements, it would be much easier to try to clean things up from the beginning of your current accounting period. You need to begin building balance sheet information, get a handle on your assets, including fixed assets, receivables, cash and investments, then move forward with liabilities. Somewhere in there you want to identify your owner's equity, meaning the initial level of investment, additional net income rolled into equity and off-set for any draws over the years (an owner draw is different than taking a salary, it affects the equity of the business enterprise.) You are probably cash-based, thus you don't need to worry about accrued payables.

A good place to start is a copy of Quick Books (the desktop version, NOT the online version)... and visit the Intuit user forums...I guarantee you're not the first who decided to formalize your financial reporting a couple of years into operations...Quick Books may even have some handy features to help you with that and it's relatively cheap, a couple hundred bucks gets you what was $10,000 worth of accounting software just a few years ago. Best of luck to you.

-db.

Admin

John Doe 30.01.2011. 05:17

What is the average down payment for a small business that is worth approximately $10,000 - $12,000? I'm considering purchasing an existing small business. The owner has not asked for a down payment, but I am considering offering one as a good faith gesture. Is there any standard practice in terms of the average amount offered for such a down payment?

John Doe

Admin 30.01.2011. 05:17

Jason is right. Most people would prefer to be cashed out. However you may be able to persuade the owner into offering Owner Financing with monthly payments. Start by asking him. Just say I would like to offer you full price for your business but I need to get some favorable terms, such as I'm willing to put down 10% and pay the balance over the next 24 months. He will counter. But this gets things rolling. Negotiate other things like him staying on for 30 days to train you. Or perhaps extra equipment.

You can also use this strategy in order to get a lower price. Just say I was really hoping you would be willing to except payments, This would allow me to use some of my funds in other areas. However, if I was able to scrape some extra cash together what would be the lowest cash offer you would be willing to except? I hope this helps and I wish you luck.

This was a business I invested in and it's been very very profitable. If things don't pan out then take a look at this http://bit.ly/cCZHJn

Admin

EK 21.08.2011. 15:09

I want to start a business but I'm a little hesitant because of the economy should I go for it or wait? I already have the business plan all mapped out and all i need is the bank loan. But with all this talk on the news about the economy going down Im not sure if i should go ahead and take a risk in starting it. Life is full of risks but I just need a little guidance and some clarification in order to feel comfortable.

EK

Admin 21.08.2011. 15:09

Some businesses thrive because of the downturn. Start slow, try to learn as much as you can and be VERY FRUGAL when it comes to spending. You don't want to burn your cash fast in this economy.

Getting a business loan is NOT easy ? especially with the tough economic climate.

You just don?t go to a bank to ask for a loan with only your business idea. Banks look at other factors not just your credit score when applying for a business loan. Banks want to see:

- demonstrated ability of the business to generate revenues -- businesses that are already operating and have at least 2 years' worth of financial statements that demonstrate strong profitability. Business ideas are just ideas; not proven to generate profits

- ability to repay the loan through collaterals and assets

- solid management team: they want to know that the business will be run by someone who knows what they are doing

- excellent credit history

- your investment in the business: they want to see that you believe in your business enough to put down your own money into the business

If you have the above, then prepare a business plan. - The business plan is NOT the first thing banks want to see. It's important, but banks will need to see your ability to repay the loan. Sometimes, they won't even bother to read your business plan if they know you don't have any money. If you have to have a business plan, you need a good executive summary (as that is what they're most likely read, if at all) PLUS solid, realistic financial projections/plans

Admin

Aaron 22.05.2013. 18:56

How to open a franchise business at 18 years old is it possible? I'm 18 years old, I don't really have money but there is this shopping center that just opened by my house and it is perfect for a GameStop or game store. I really want to open one up! I know it sounds silly but I'm really serious. Is this goal achievable? I know I need to learn a lot more about business and how it works. I'm a smart girl and I plan to figure some of it out this summer but is it even possible? I'm young and I know my business would be successful but am I in over my head? How would I even start my business? What is necessary to start a franchise? I'm going to college soon and just really want some advice.

Please give advice and opinions. Thanks

Aaron

Admin 22.05.2013. 18:56

No way for GameStop since all GameStop stores are company owned.

In order to own any franchise or open your own store, you are going to need cash, a business plan and probably a loan. lenders will not provide business loans to someone who does not have at least 25% of the cost to open the store in cash (you figure out the cost in the business plan - if you try to inflate the figures to get more money, they are experts and will know).

Also, most franchises want you to have a net worth of $200,000 or more in addition to your cash for the franchise.

And finally, you can't go to college full time and run a franchise or a successful business - this is a fulltime job (60 to 80 hours) and would leave you no time for classes and/or homework.

Go to college, get a business/entrepreneur degree and then think through what type of business you want, get the hands-on experience by working in the industry and then get your franchise when you are 30 - 35.

Admin

lpatt42 17.10.2011. 22:57

How can it be argued that petty cash is a liability? What business conditions deem it worth having or not, in your opinion?

lpatt42

Admin 17.10.2011. 22:57

It CAN'T. A liability is something you OWE to another party. It may not be worth keeping much cash physically on hand, but it is NEVER a liability.

Admin

K 07.07.2006. 23:57

How do you open up a retail business? I would like to know steps to start a business (not procedures, but the research involved to make sure the business is successful).

Something to consider answering...

Mostly on business planning:
1. How do I find a good distributor/wholesaler?
2. How do I manage the inventory (or how much I should buy initially)?
3. How do I minimize tax?
4. How do I choose a good location?
5. What kind of return should I expect before I put my money in?
6. How do I know if my idea will be practical?
etc.

I am looking for some thorough answers. Thank you VERY MUCH! I do not have a very good knowlege and would like to hear some experienced entreprenuers.

K

Admin 07.07.2006. 23:57

1: Internet, merchant shows-look in you local paper or the Internet
always try to go to the source, cut the middle man
2: i would manage the inventory on a spread sheet in Microsoft works, on your inventory u kinda want to start with a few of each items to see what is selling and what is not, it will be hard to see what your going to need until you are there for a month
3: It is a cash based business, you will get really good at hiding money
4: traffic count, people in the area, competition
5: depending on you economy any where from 300% to 500% on a retail business, that is on items, business worth is normal 3 times sales
6: If you treat people how you want to be treated, keep you prices in the range where you would pay for item your self at another store, and appearance

Admin

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