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Posted on October 26, 2009

Contributed by Bob Klein

Valuing A Small Business: Searching for Market Value


There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%.

Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work.

Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised.

Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values far from Market Value.

After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal.

About The Author:  Bob Klien is President and owner of Business Appraisals, providing Market Value business appraisals on all types of businesses. Former President and owner of Business Search, Irvine, California, a Merger & Acquisition firm specializing in the sale of manufacturing, distribution and related businesses, with programs for both buyers and sellers. Phone Bob direct at 800-829-4842 or 949-254-406 about more information regarding business valuations.

Watch for more blog posts / articles from me in the future!

See all contributions from Bob Klein

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Comments:

I have been evaluating businesses for so long and using the different methods for so many years that just the thought of it gives me a headache. Sometimes I have told a seller what a business will go for and I nailed it. But just as often I have been high or low by several thousand dollars. I give a prediction of what a business will bring and then compare that to what it sells for. Sometimes I believe that evaluating a business is just guess work. Now, in talking to sellers and also when testifying as an expert witness, I am only comfortable by quoting a range of value. There are too many unknown variables to really make this a science that will allow me to pick an exact number.

Posted by: Steve C.

It seems to me that there is a decline, somewhat, in what people are willing to pay for businesses right now. It's a direct result of the fact that profits are down because business is off. There are exceptions of businesses that are doing fine, or even better. But most are feeling the economy and it hurts sales and that translates to a lower price. But it's a mistake to say that the multiples are down. I don't think so. If a business in a certain industry is worth around 2.5 X EBITDA, that factor won't change. The reason the price might go down is because of EBITDA going down. But the 2.5 wouldn't change.

Posted by: Alex Max

Since most (but not all) small businesses are purchased by people who are going to work in them to make a living--buying a job, in other words--the value of any business is mostly a function of how much money it's going to provide to the owner. The profit (or cash flow, or income, whatever you want to call it) is not only a return on the money invested, but also it is the compensation for the seller in return for the hours put into the operation. The value needs to be a multiple of whatever that income is, and the size of the multiple is really a matter of demand and supply. With few good businesses for sale and lots of buyers looking, you're going to see the multiple go up. Of course if there are lots of businesses available, it is competitive pressures that will drive down the multiple.

Posted by: David H.

Bob mentions the "comps" method and I think that it is one way to work out the price for a business in theory. But the problem is that you'll never find two businesses that can be compared like-for-like, the way you can do with houses or cars. How do you come up with a comp on a one-of-a-kind business in a specific area? Answer is, you really can't.

Posted by: Jeff K.

In my experience, the best method to use when valuing a small business is cash flow. If the buyer can determine after tax cash flow current and future, then it is just a matter of adjusting risk.

Posted by: James Chamberlain, SCORE

Your approach of combining assets, income and market factors is probably the way to go with determining what a business SHOULD sell for. But when you say it gives an "accurate market value," remember it's only accurate if the business sells for the amount you said it was worth. If it sells for more or less, and under normal conditions without undo pressure on anyone, then the value you gave it is not accurate.

Posted by: Chaz A.

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