You know your business’s revenues, and you know its expenses, but do you know what it’s actually worth? Knowing the value of your business can save you money if you ever decide to sell, merge, or otherwise dispose of it. Here are the key issues in determining the worth of your small business.
Why Know Your Business’s Worth?
As long as your business is growing and making money, do you need to know its exact value? The answer is not always, but it never hurts. Sometimes simple curiosity sets in. You hear about a business sale in your industry and start wondering, "Hmm, I wonder what my business would sell for?"
Other times, there’s a pressing need to know. A partner is moving on and wants to cash out. You’re considering selling the business. You run the company with your spouse and divorce looms. In these situations, knowing your business’s value can help you get the most out of the impending transaction.
Qualities and Qualifications of a Good Business Valuator
Valuing your business involves some advanced calculations. Some business owners have no problem with that. If you majored in accounting or math, you might decide to go for it. Others say "No way." If that’s you, a business valuator can crunch the numbers for you.
If you’re going to pay a business valuator, you want to go with someone who has experience and can do the job right. For many business owners, that means looking for someone with the CBV, or Chartered Business Valuator, designation, which signifies advanced training specifically in business valuation.
To locate a CBV near you, check out the Canadian Institute of Chartered Business Valuators. On its website, you can search by province for CBVs.
Your Business Valuator’s Role and Responsibility
The services of a business valuator don’t come cheap. You might be set back several thousand dollars. But if you’re selling your company or negotiating the exit of a partner, a few thousand dollars is nothing compared to what you can gain from an accurate valuation of your business.
When paying that kind of money, though, you should know what the valuator is giving you in return. The best business valuators have strong backgrounds in math and accounting. They can handle advanced calculations such as discounting future cash flows and depreciating assets. In the end, you want to be sure the most accurate valuation gets assigned to your business.
Aside from fees and qualifications, another trait to look for in a business valuator is confidentiality. They shouldn’t reveal the name of your business to anyone until a deal is on the table.
Rules of Thumb
In many industries, rules of thumb hold sway over business prices. These rules, some of which might seem esoteric, offer simple calculations to determine the fair selling price of a business.
A few common rules of thumb:
- Retail apparel store: one-and-a-half times seller’s discretionary earnings plus inventory.
- Book store: 15 percent of annual sales plus inventory.
- Retail auto parts stores: 40 percent of annual sales plus inventory.
- Dental practice: 50 to 60 percent of annual gross revenue.
While these rules can provide a helpful starting point, they aren’t the be-all-end-all. Consider two dental practices, for instance, both with the same annual gross revenues. One is buried in debt and untenable expenses. The other is debt-free and consistently profitable.
Would anyone thinking clearly bid the same amount for these two practices just because they have the same gross revenues? Of course not. That’s why rules of thumb should be thought of as a guide and not a panacea.
Goodwill and Other Intangible Assets
Not all your business’s assets are tangible. If you or your business valuator ignore intangible assets — particularly goodwill — you risk undervaluing your business. It is a good idea to mention goodwill and other intangibles to any business valuator you’re considering hiring. That way you can make sure you’re on the same page.
What is goodwill? It consists of your business’s positive reputation, knowledgeable staff, customer relationships, and other intangible items that imbue it with favor or advantage.
Occasionally, you run across a buyer who claims they don’t pay for goodwill or intangibles. Upon encountering such buyers, smart sellers lace up their New Balances and run in the opposite direction.
The Role of Buyer and Seller Perspectives
Sellers often perceive the value of their business in raw numbers — profits, earnings growth, and the like. But it’s important to consider the ways a buyer’s perspective can differ.
A few characteristics important to buyers:
- Management and employee stability. Is the buyer going to have to replace the whole staff from the top down? If so, that’s an added expense not captured in most valuation measures.
- Growth prospects. Not just for the business, but for the industry as a whole. A Blockbuster Video franchise might have had great raw numbers in 2008. By that point, though, any savvy buyer should’ve seen the writing on the wall for the video rental industry.
- Competition. A looming threat from a competitor, such as a popular chain coming to town, can depress the perceived value of your business to a buyer.
Before you sell your business, cash out, or split with a partner, getting an accurate valuation is crucial. Knowing the steps to take and who to trust can save you a lot of money in a major transaction.