How much is it worth? You’ve put a monstrous amount of work and time into your business, perhaps now its time to figure out what all of that sweat and stress is really worth. Maybe you are applying for a loan, raising money for expansion, talking with investors, or considering selling. Consider this, there are as many ways to value a business as there are potential reasons for valuing it.
Big Dollars For My Biz
Also, value is in the eye of the beholder; a banker will have totally different criteria than a potential business partner or investor. Below are some of the principle factors in calculating the value of your business as well as a listing of professionals that could help you put everything together and arrive at a number.
Principle Factors or Methodologies in Valuing a Business
- Discounted Cash Flow – this is the methodology famously endorsed by Warren Buffet when he evaluates a business. In its essence it involves taking the amount of cash flow you expect a business to generate in the future and then discounting that at some rate (perhaps U.S. long term t-bills or your required rate of return) to get a present value. The math is simple using Excel, but this methodology obviously requires a great deal of estimation. Don’t let the preciseness of the number fool you, in fact, you may wish to get a range based upon several different estimated cash flows and let that be a general guide.
- Value of underlying assets – this is what would concern your banker or the court-appointed trustee of your bankruptcy. Basically, this would require going down the balance sheet of your business and marking everything to its value if you had to sell it right now and then subtracting what you owe to others from that. The problem with this methodology is that it only works if your business sucks. What if your business requires very little capital to be successful but still kicks out tons of cash and profits each year, which you then use to line your pockets? Clearly this methodology would grossly undervalue your business.
- Growth potential – This is how the internet businesses of the dot.com bubble era got their outrageous valuations. If your industry is hot enough and your business plan is sexy enough then your business may be extremely valuable even though your profits and cash flow are negative and your liabilities are greater than your assets. In other words, people would be willing to put money into it now to keep it going until the day that they gamble it will really take off and pay them back many times over. Pretty much every business starts this way, the owners invest time and money now in hope of future profits down the road. Evaluating that “future profit down the road” is more of an art than a science.
- Comparable business - You see this all the time in the stock market, the stocks of certain sectors correlate with one another because businesses from the same industry face similar economic realities and thus when one is sold it provides a benchmark price for all similar businesses. Sure, you can expect your business to be worth more or less depending upon factors unique to it, but a potential appraiser might take that other business as a basis and then make adjustments to it to get to the value of your business.
- Synergies - often when an existing business business is purchased the buyer is another business that is looking for synergies that can be exploited by uniting the two businesses. The synergies could come in the form of uniting new technology, more efficient purchasing through economies of scale, lowering cost by sharing overhead, or cross-selling in complementary markets. For a big business example think of a big pharmaceutical company buying out a bio-tech firm to access new technology and diversify its products. Closer to home, if you run an online store that specializes in hip handbags for young, professional women you might be bought out or merge with another online retailer that has a niche in chic but not-too-expensive jewelry for a similar clientele. The merger would allow them access to your client lists and a chance to cross-sell their product through your channels, as well as the continued revenue of your business. This creates synergy and might mean that your business would be more valuable to this potential buyer than to someone who doesn’t yet have an online presence.
A Second Opinion
A number of professions have sprung up that provide specialists in valuing businesses. The BizSeller has already put together an excellent list, so I will use an excerpt of their post and add hyperlinks to the institutions mentioned.
- Initials: C.B.A. Title: Certified Business Appraiser Institution:Institute of Business Appraisers
- Initials: A.S.A. Title: Accredited Senior Appraiser Institution: American Society of Appraisers
- Initials: CPA/ABV Title: Certified Public Accountant Accredited In Business Valuation Institution: American Institute of Certified Public Accountants
- Initials: CVA Title: Certified Valuation Analyst Institution:National Association of Certified Valuation Analysts
Why would you need a specialist? Usually, if you are calling in one of the above professionals, it is because you are being asked for an independent third-party valuation by a potential lender, by the courts, or you need to provide it for estate tax purposes.
How does the specialist arrive at a price? Usually the specialist takes the factors above that they feel are most relevant to your business and then run a set of calculations using a range of factors. They do the math several different ways to provide a range of potential values and then they pick a number and the middle of the range and then, abracadabra, just like a magician pulling a rabbit out of his hat the specialist pulls a number out of her, well, range of numbers. This is great fun in divorce cases or other legal cases because you get two specialists, one representing the plaintiff and the other the defendant, coming up with two very different values. Almost invariably each specialist (expert witness, in this case) chooses a number that favors the party that pays them.
Conclusions
- The business has different values to different people
- There are many different ways to value a business
- Retained Earnings have little to do with value
- Earnings + positive cash flow = great business, earnings + negative cash flow = future bankruptcy ,
Please leave your questions or offer your solutions below. As the WebCPA and the author of WebBizFinance.com, my job is to help you grow your business and solve your business finance and accounting problems!
Tyler
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