Valuation Is Critical to Every Business Sale

Determining a business’s value is not as simple as profit and loss. When asked, many, if not most, small business owners do not have a firm answer to give to the question, “How much is your company worth?” A number of variables are at work in the valuation of any business. This is by no means a simple mathematical equation.

How do you measure valuations?

Valuations are typically done in multiples of EBITDA, or earnings before interest, taxes, depreciation, and amortization. EBITDA is a measurement of cash flow allowing interested buyers to roughly determine how much revenue a business will generate over a period of time. Sometimes EBITDA is adjusted to subtract expenses that a new owner would not have, often for items that are tax write offs like membership dues or for losses or gains that will not be repeated such as the sale of a large piece of equipment. When done correctly, the EBITDA will reveal predictable revenue – how much money that business could be expected to earn over, for example, five years.

It’s important to note, however, that the quality of the revenue is more important than the quantity of it. The bottom line is how profitable the business is and also how predictable that profitability is.

What else goes into a business valuation?

Physical property – including buildings and equipment – also factors in, of course. But for property to be a factor in measuring profitability, it has to help generate revenue in an of itself. A manufacturing company cannot run without its machines, for instance, while office equipment may be either replaceable or already outdated. Does the location of the business affect its profitability? Does the business generate more revenue because it is located there? If so, its physical plant asset is important to include in the valuation.

Intangible qualities must also be evaluated. What is the company’s reputation in the industry? Does it have significant intellectual capital? How unique are its products or services? What is its management structure like, and does it run independently of its owners? If the business is only making sales because of the connections the current owner has within the industry, that is unlikely to transfer to new ownership and will strongly affect valuation.

A business’s client base is also important – how large and stable it is, and how much repeat business it generates. Again, if the company is earning most of its revenue because of one or two business relationships, most buyers will not take for granted those relationships will transfer. The valuation will be lower because of this.

Why is it important for business owners to know the value of their business at any point in time?

Owners who aren’t interested in selling will probably also not be interested in paying thousands of dollars to have a professional valuation done, but knowing the value of a business is important even if it fluctuates. A baseline valuation is a starting point for a more successful negotiation, and having one, will give an owner an advantage in selling his business for a good price. It may also reveal vulnerabilities about the business that the owner could address, making the business more profitable and more salable at the same time.

The bottom line is, no business owner should consider selling his business without a solid grasp of what it is worth on the market. Starting and running a business is a significant commitment and accomplishment. Do not jeopardize the worth of what you have built by not knowing what value the market is likely to bear.

Lastly, make sure that you are aware of three critical factors to consider when hiring a business appraiser.

For no fee or obligation, we would love to discuss business value and the sale process.