When a small or mid-sized business is offered for sale or is the subject of negotiations between a buyer and the seller, a key issue is the business valuation. In other words, what is the business worth? There are no manufacturer’s suggested retail prices as often are attached to new cars, or comparable sales charts to give clues about the value of homes on the market. There is no “Bluebook” listing appropriate prices for many models of used vehicles. Because no two businesses are alike, it is very difficult to establish what might be an accurate business valuation for a particular retail store, distribution service, restaurant, vehicle repair or other kind of company.
But there are several theories and methods used by accountants, business intermediaries (brokers and agents), financial institutions and others to offer a “best guess” recommendation about what should be the selling price, and thus the market value of a business.
The most popular and probably the most accurate methods of business valuation focus on the buyer’s anticipated return on investment. One commonly used approach relies on a formula that ties the value of a company to its income. It stands to reason that the more money a company makes, the higher its business valuation. Among these methods is a computation that includes the seller’s discretionary annual income and multiplies it by a factor customary for the industry in which the business is involved. If restaurants in a particular location typically sell for about 2.5 times the owner’s average annual discretionary income over the past five years, the seller who collects $100,000 per year can estimate that her business is worth about $250,000. This multiple varies from industry to industry and location of the business, and is influenced by other factors, such as terms of the deal.
Another business valuation method simply totals the market value of the assets of a company. That includes equipment, furniture, fixtures, and other tangible and intangible assets. That’s not an accurate indicator of market value, however.
The ultimate rule of business valuation is, of course, whatever price the buyer and seller agree on, assuming there is no extreme pressure on either party to make a deal at any cost.