What is my business worth? I’ve asked this question many times before. Not because I want to sell it. I have worked really hard to build this business, and it’s just nice to know how much it’s worth. If you work as hard as you do, you also deserve to know the value of your small business.
And this is smart even if you’re not planning on selling it today. Remember, if you can’t sell your business, all you really have is a job. Maybe you think you have a great small business, but what you really have is a high-paying job. There is nothing wrong with that. But if you can’t sell your business, it’s not a business. You might think that you’ll sell your business when you retire. But if you can’t sell it, it doesn’t have any value. You’ll have to save money for retirement in some other way. That’s why you need to know what your business is worth.
This post is intended to show you how to do your own small business evaluation and appraisal. Later posts will show you how to increase that value going forward. Keep in mind that you need to find out what your small business is worth to someone else who is buying an existing business. It doesn’t matter what it’s worth to you. Keep that in mind as we go through the following materials.
In the real world, many small businesses are bought and sold without paying attention to facts. Buyers try to determine how badly you need to sell and what’s going on in your personal life. They also consider the overall state of the economy in determining price. Those external considerations often impact the price of a small business far more than they should – and not to your benefit if you are the seller. If you want to get the highest price possible when you sell your small business, don’t discuss your personal life. Stick to the facts about your small business. That’s the best way to get the best price when you sell your business.
A fair way to value your business is to take your net income (after you deduct a fair salary for yourself if you work in the business), add back in any personal expenses the business picks up for you and multiply that by a standard multiplier. If the business owns property or inventory, you’d add that too. You might be selling to get business debt relief. If that describes you and you have liabilities, you’d subtract that from the value of your small business.
Let’s assume your small business doesn’t have inventory, assets or liabilities. It’s a service business. Let’s take an example. Say your business grosses $500,000 a year and the business runs $400,000 in expenses each year. But $50,000 of those expenses are for items that you’d have to pay for personally if the business didn’t pick up the tab. (I’m not encouraging you to have your business pay for personal expenses, but some people do it.) If that describes you, you have to add that $50,000 back into the net income. In other words the real business expenses are only $350,000, even though you declare $400,000 for tax purposes. So the new owner would run the business and have $150,000 in profit each year.
But wait, the new owner might not work in the business. She might hire a manager to run it. Let’s say she could do that, but she’d have to pay $60,000 to the person she hires. That being the case, the real net income of your business is probably around $90,000 each year before tax. ($150,000 profit less $60,000). This is what’s called the “free cash flow” from your business. It’s a very important number. We’ll come back to it in a bit.
1. History Lesson
Do the exercise above on your business’ income over the last three years. Run a few reports from your business budgeting software. What was the free cash flow from the past few years? Is it rising or falling? Why? If it’s going up, explain what you’ve done differently and what the new owner can do to keep that trend moving. If it’s declining, you need to explain why. And you’ll need a strong argument to convince the buyer that the decline can be reversed.
If the free cash flow is rising, you can easily ask for 10 times last year’s net returns. So, in the example above, you should be able to ask $900,000 for a business that earned $90,000 net income if that income is increasing. If the net income is declining, you’ll be lucky to get five times last year’s return. That’s because the risk is increasing and the buyer won’t like that risk. If that were your situation, you’d be lucky to get $450,000 for your shop.
Buyers pay more for business when they perceive the risk is low. Find out as much as you can about the buyer. Does she have prior experience in the industry? Does she own other stores like yours? Does she have trained personnel lined up and ready to take over? All these assets make your position stronger because they reduce your buyer’s risk. Find out as much as you can and try to point out to the buyer how low the risk is for her in her particular situation. Is this person buying the business as a way to supplement her retirement income? Is she going to try to grow the business dramatically?
And try to reduce risk for the buyer (and yourself) as much as possible. One of the most important things you can do is keep an eye on employee theft. This is a huge money drain and the reason why up to a third of all companies fail. Institute anti-theft procedures and show interested buyers all you’ve done to minimize this risk. It will make your company all the more valuable to them.
Of course, you should always be honest. If there are pending landmines, you must disclose them. If you think the person is walking into a hornet’s nest, tell her. Your karma will be better and you’ll spend less time in court if you do.
3. Market Research
The multiplier I mentioned above is a rule of thumb that varies from industry to industry. Find out what businesses like yours sell for. Check out eBay, Craigslist and other online sites that sell businesses. This is probably your best indicator.
The more you prepare yourself with facts, the better you’ll do when you sell your business. Don’t look for someone to pay you what you think your business is worth or to compensate you for all the hard work you’ve put into your business. Be honest and realistic when you are selling your business and do your homework instead.