As a business broker that is one of the first questions I get from prospective clients interested in selling their business, and rightly so. But on further discussions with the client, I am often surprised that many business owners have no idea of what their business is worth or what it might sell for in the market place.
Often times a business is an owner’s most valuable asset and with that, knowing the value would be important for retirement and estate planning, partnership buy/sell agreements, available capital for a new venture or other needs after a business sale. Having a general idea of the value of the business can save a lot of heartache down the road. This is probably not surprising, but many business owners over estimate the value of their business, which affects real world scenarios such as adequate funds for retirement.
Having a business valuation should be part of every owner’s business plan and exit strategy. Someone that is not vested in or tied to the business so as to take the emotion out of the valuation process should prepare the valuation. Most times your accountant seems like a logical choice for a valuation, but it is human nature to want to provide good news. Have your accountant recommend another accountant or employ a professional valuation company or business broker to provide a valuation.
There are typically two types of valuations, non-accredited and accredited. A non-accredited valuation is good for internal planning purposes and non-disputed values for a business and will generally cost less than $500. A business broker or accountant can provide these for a business owner. Instances where a business valuation might end up in court for reasons such as divorce, partnership disputes, or IRS matters will require a valuation from an accredited company. Depending on the depth and support needed for the valuation, these can cost $3,500 and up. Make sure you have a clear understanding of what type of valuation for which you are paying. Accredited valuation companies will have designations such as CBA, ASA/AM, CVA and ABV.
Business valuation has a bit of art, market experience and pricing formulas that go into the value. After all, a business is really only worth what a buyer is willing to pay for it. Some will pay more, some won’t, so a valuation is a general range of the business’ value and not a dead on price.
I am going to provide a general down and dirty method for business valuation. Ultimately the purpose of a business is to make money and because of this, the valuation is most often tied to the annual cash flow or discretionary earnings of the business. There are several definitions of cash flow, but for our purposes we will define it as the total of an owner’s salary, plus the profit from the business operations, plus the perks the business provides the owner.
Businesses fall into 5 broad categories, manufacturing, wholesale/distribution, service, retail, and foodservice. And for those categories the following general multiples of annual cash flow help us arrive at a value.
- Manufacturing – 4 – 6x cash flow.
- Wholesale/distribution – 3.5 – 5x cash flow.
- Service – 2.5 – 3.5x cash flow.
- Retail – 1.5 – 2x cash flow plus inventory at cost.
- Foodservice – 1.5 – 2x cash flow.
So for example if you had a service business such as a plumbing, landscaping, or pool cleaning company and the owner’s cash flow was $100,000 a year, then using the average of 3x cash flow, a general value for the business would be $300,000.
As mentioned, these are general guidelines and nothing replaces a business specific valuation where asset value, inventory and other factors are also taken into consideration. Be prepared. As a business owner you owe it to yourself to be proactive so you can plan for your and your family’s future after you sell your business.