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Discussions > How Do I Determine the Value Of My Business? Or, The One I Want To Buy?
How Do I Determine the Value Of My Business? Or, The One I Want To Buy?
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Posted By: Timothy Cunha JD 
How do you determine the value of your business when you go to sell or even buy a business? There are so many factors and that is usually one of the first items serious buyers inquire about. When a business broker or agent goes to sell a business this should be one of the first tasks they perform.
Topics: Business Valuation, Buying A Business, Selling A Business Tags: business valuation, buying a business, selling a business
How do you determine the value of your business when you go to sell or even buy a business? There are so many factors and that is usually one of the first items serious buyers inquire about. When a business broker or agent goes to sell a business this should be one of the first tasks they perform.
Topics: Business Valuation, Buying A Business, Selling A Business Tags: business valuation, buying a business, selling a business
Contributor: Timothy Cunha JD: Business Broker, SF Bay Area
Often, I'm asked, "Aren't all businesses worth the same multiple of profit or percentage of sales? Profit is profit, and a dollar is a dollar, right?"
To answer, I usually ask an absurd question: "Which is more valuable, the business that requires getting out of bed at 2 a.m. and driving through alleys of San Francisco collecting recyclable trash, that grosses $500,000, and nets $150,000; or, the business that rents out chairs and umbrellas on the beach in Santa Cruz on warm, sunny days, and also grosses $500,000 and nets $150,000?" Of course, the obvious answer is that the beach chair business is far more valuable. It's all about commitments of time and the lifestyle enjoyed by the owner.
And, that's what "rules of thumb" answer. How is this particular business or industry regarded by previous buyers? How did they value the gross and net revenue because of the type of business? With the right data, we can calculate the numbers and find the ROI, EBIT, EBITDA, "net cash flow", and "SDE"; but, only actual past human behavior indicates what those abstract numbers mean to real buyers.
Business brokers are very familiar with two typical ways of providing a quick value estimate for a small business, using comparable sales of similar businesses: (1) a percentage of gross revenues, and (2) a multiple of seller's discretionary earnings ("SDE"). These work fairly well at estimating a realistic fair market value range in the majority of cases, especially when the business is not all that unique and there are plenty of comps.
But, in those situations where the fair market value is more complex because the business is unusual or nonconforming and there are few comps, I use a variety of methods. One is to calculate the full replacement cost of the physical assets (adding 25% to cover sales tax, acquisition, freight, and installation costs), plus the cost to replicate the customer base, plus any cost to replicate intellectual property, plus a value on the time-to-market advantage of buying an existing company rather than starting from scratch. But, there are many other methods, with the ultimate purpose to determine the potential actual value of the business to the most likely buyer.
To answer, I usually ask an absurd question: "Which is more valuable, the business that requires getting out of bed at 2 a.m. and driving through alleys of San Francisco collecting recyclable trash, that grosses $500,000, and nets $150,000; or, the business that rents out chairs and umbrellas on the beach in Santa Cruz on warm, sunny days, and also grosses $500,000 and nets $150,000?" Of course, the obvious answer is that the beach chair business is far more valuable. It's all about commitments of time and the lifestyle enjoyed by the owner.
And, that's what "rules of thumb" answer. How is this particular business or industry regarded by previous buyers? How did they value the gross and net revenue because of the type of business? With the right data, we can calculate the numbers and find the ROI, EBIT, EBITDA, "net cash flow", and "SDE"; but, only actual past human behavior indicates what those abstract numbers mean to real buyers.
Business brokers are very familiar with two typical ways of providing a quick value estimate for a small business, using comparable sales of similar businesses: (1) a percentage of gross revenues, and (2) a multiple of seller's discretionary earnings ("SDE"). These work fairly well at estimating a realistic fair market value range in the majority of cases, especially when the business is not all that unique and there are plenty of comps.
But, in those situations where the fair market value is more complex because the business is unusual or nonconforming and there are few comps, I use a variety of methods. One is to calculate the full replacement cost of the physical assets (adding 25% to cover sales tax, acquisition, freight, and installation costs), plus the cost to replicate the customer base, plus any cost to replicate intellectual property, plus a value on the time-to-market advantage of buying an existing company rather than starting from scratch. But, there are many other methods, with the ultimate purpose to determine the potential actual value of the business to the most likely buyer.
Contributor: Business Appraisals, Valuations Advisor
An ACCURATE business appraisal is much more difficult to create than most people realize. Rule of Thumbs and Comps are useless as they typically represent the average value of a specific type of business. In every class of businesses there are the well run and the poorly run examples. How do you know which end of the scale the business you are looking at ranks? Rule of Thumbs and Comps also do not address the asset value or the condition of the assets. Each business is unique and must be appraised as a unique entity.
ROI, EBIT, EBITDA and SDE based methods do not look at asset value and condition or market influences that affect value.
Percentage of gross revenues has little importance on a business’s value. I once appraised a business doing $20,000,000 in sales with less than $200,000 in adjusted cash flow. Its appraised value was just over $300,000. Gross revenue is not a good indicator of business value. On the other hand, seller’s discretionary spending is an important factor, but it doesn’t present a full picture of the business’s value.
Valuing equipment assets are never based on replacement value except possibly in an insurance claim. Fair Market Value based on the original purchase price is used by business appraisal professionals. This is 50 to 75% of the original purchase price depending on type, age and condition of the equipment. No other arbitrary additional cost can be associated with the equipment, customer base or business age.
ROI, EBIT, EBITDA and SDE based methods do not look at asset value and condition or market influences that affect value.
Percentage of gross revenues has little importance on a business’s value. I once appraised a business doing $20,000,000 in sales with less than $200,000 in adjusted cash flow. Its appraised value was just over $300,000. Gross revenue is not a good indicator of business value. On the other hand, seller’s discretionary spending is an important factor, but it doesn’t present a full picture of the business’s value.
Valuing equipment assets are never based on replacement value except possibly in an insurance claim. Fair Market Value based on the original purchase price is used by business appraisal professionals. This is 50 to 75% of the original purchase price depending on type, age and condition of the equipment. No other arbitrary additional cost can be associated with the equipment, customer base or business age.
Contributor: Timothy Cunha JD: Business Broker, SF Bay Area
Ultimately the "value" of a business depends on the benefit to be derived by the unique purchaser ... and that can vary from buyer to buyer. In broad terms, there are three kinds of buyers: the "career seeker", the "absentee (or semi-absentee) investor," and the "strategic player" (already in the business and seeking a marketing or operational advantage by acquisition). For each of these buyers, the "value" of the business may be significantly different.
Another factor to consider is how long the buyer intends to own the business. If it will be only a very few years, what the "market" says the business is worth is very important because it will face the market again in a relatively short time. If the buyer intends to hold on to the business for 5, 10, 15 years, and it serves the goals and purposes of that buyer, what the buyer considers its "worth" to be is far more relevant than the market's opinion.
Often, the prospective buyer needs to consider a "make or buy" decision--whether it is more economical to purchase a business than to start a business "from scratch." In my experience, it is almost always preferable to buy an existing (healthy) business. One of several criteria for making that determination is what it would cost to replace all the essential FF&E of the existing business; this is not for the purpose of valuation of those assets in an abstract or discrete sense, but rather for the comprehensive purpose of evaluating the relative merits of business acquisition versus business formation.
Another factor to consider is how long the buyer intends to own the business. If it will be only a very few years, what the "market" says the business is worth is very important because it will face the market again in a relatively short time. If the buyer intends to hold on to the business for 5, 10, 15 years, and it serves the goals and purposes of that buyer, what the buyer considers its "worth" to be is far more relevant than the market's opinion.
Often, the prospective buyer needs to consider a "make or buy" decision--whether it is more economical to purchase a business than to start a business "from scratch." In my experience, it is almost always preferable to buy an existing (healthy) business. One of several criteria for making that determination is what it would cost to replace all the essential FF&E of the existing business; this is not for the purpose of valuation of those assets in an abstract or discrete sense, but rather for the comprehensive purpose of evaluating the relative merits of business acquisition versus business formation.
Contributor: Broker/Consultant: Elderly Care Services
I find it interesting that if I ask 3 different Appraisers to give me a value on a business, I will receive 3 completely different values. I agree with the Author that lifestyle, convenience, sustainability, and growth opportunities all play a role in value, but certainly make it hard to place a price tag on a business.
There are many factors that can affect a sales price, such as high rent, location, level of expertise that a new owner may need to properly run the business, etc. Working with enough buyers, I have found that most expect to receive a ROI with 2-3 years, and then want to make sure that they have enough time on the lease, so that they will be able to sell in the future.
Thank you for the great article. You are absolutely correct. In the end it comes down to What a Buyer is willing to Pay and a Seller is willing to accept. So, coming up with the comparable value is a basis. Most would pay more for the life on the beach, but both options need to be tested. The problem is of course beyond substantiating the numbers, which I see dominate most Buyers decisions. Unfortunately, this often leads to a rush of judgment. A business purchase, especially one with equipment or Lease dependent requires a great deal of Due Diligence in various areas, beyond the numbers. I also agree that unless a business is performing at Model Levels it should be looked at from all directions including, unit in place, sustainability testing, Lease conditions and competitive position and potential are all tests that should be conducted if one is diligent. Business Acquisitions absolutely fit the Message "Buyer Beware".
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Joe Sandbank, Esq: Legal Services For Buyers, Sellers, Brokers - Throughout California I have provided legal counsel to business buyers, sellers and brokers for over 17 years. With prior experience as a business broker and SBA loan officer, Joe brings both a practical and legal approach to all aspects of the business acquisition process. Please phone 916-672-8018 for more info. |
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Diane Boudreau-Tschetter: Escrow And Bulk Sale Services - California California Business Escrow, Inc. is a full service independent escrow company serving all of California and has expertise in a wide range of escrows. Our team prides itself on providing an exceptional escrow experience. For more info phone Diane Boudreau-Tschetter at 888-383-3331 or 209-838-1100. |
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Willard Michlin, CPA, Certified Fraud Examiner, Due Diligence Services - California Willard Michlin, CPA #106752, offers buyers step by step training & assistance in doing Due Diligence Services when they are thinking of making an offer, or are in process of investigating a business purchase. He helps to determine the actual net profit even when there is cash. Call 805-428-2063. |
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Taj Randhawa, Business Broker Specialist - Gas Stations, Liquor Stores If you are interested buying or selling a gas station, liquor store feel free to phone me for a consultation. My vast experience & specialization in gas stations & liquor stores helps me in serving my clients with full confidence, trust & sincerity. Serving Central Valley, SF Bay Area. 559-259-4247. |
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Jeff Sacher, Business Broker - North Bay Restaurant, Retail Specialist Jeff is a leader in business brokering in the North Bay. Since joining Santa Rosa Business And Commercial in 1999 he has assisted Buyers and Sellers in over 200 business sales and acquisitions. Jeff provides other services for his clients as well. Reach Jeff and his team at 707-888-4972. |
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Rob Hartman: Business Broker, SF Bay Area Business brokerage services in the SF Bay Area. I bring skill, integrity and energy to all of my clients and our projects. I'm accustomed to working with a wide variety of clients and their businesses; large or small, simple or highly complex. Get a free consultation by phoning 650-279-3097. |
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