After barely exchanging handshakes, the first thing a Business Owner wants to know is "What is my business worth?"
The short answer is, "Your business is only worth what someone is willing to pay you for it."
The long answer is a lot more complicated. At last count, after 12 years of helping owners sell their businesses, I've come across at least 17 different "official" valuation methods such as the critical factor method, the debt capacity method, the book value method, the excess earnings method, etc.
And that doesn't count those proposed by well-intentioned clients who had "an uncle who sold a business one time ..."
One of these methods was proposed by "John," a well-known local restaurant operator who, wanting to retire, was interested in selling the eatery that had been in his family for two generations. John absolutely was convinced that his business was worth a certain amount because of the days of the week and the hours he was open. John felt that the value of his business was linked to his being open 12 hours a day, six days a week.
He felt that his business was worth more by not being open a seventh day.
Unfortunately, no consideration was given to the revenues and profitability that could have been generated on the extra day.
Entire books have been written about valuation, and so many variables are involved (and many of them subjective) that different "experts" looking at the same company could formulate different recommendations.
Since the value ultimately will depend on both the buyer and seller agreeing on a price, one of the most effective methods is known as "cash flow."
The cash flow method allows the seller to paint a picture of the business' true profitability. It starts by identifying the net profit of the business and then "adding back" any discretionary expenses. The resulting number is the business' cash flow.
Buyers typically are comfortable with this method because, at the end of the day, although they are buying a company, what they really are buying is its cash flow.
With an understanding of a business' actual cash flow, different multipliers can be applied to determine a fair market range of value for the business. Multipliers vary depending upon the type of business. For example, a manufacturing facility likely would have a higher multiplier than a service business.
Of course many other factors can affect the multiplier. For example, new products in the pipeline, strong market share and a diversified customer base (i.e. no customer represents more than 10 percent of sales) can positively affect the multiplier.
Conversely, outdated inventory, declining market share and the risk that key personnel could leave the business and disrupt operations could have a negative impact.
You'll notice that this method contains no mention of assets furniture, fixtures, equipment and inventory having a role in the valuation of a business. That's because while those items contribute to establishing cash flow, they by themselves have limited value.
Assets are considered when a business is being sold under less-than-ideal conditions, such as when the company has no profits or cash flow. In those cases, assets would be used to determine the value of the business.
Problems then arise in establishing the worth of those items. Typically, buyers usually aren't interested in buying these businesses because the seller already has proven that the company hasn't made a profit.
Granted, there can always be exceptions in trying to identify a business' value where the cash flow method may not work.
Brad Bottoset is owner/broker of The Liberty Group of Nevada LLC, a business brokerage in Reno. Contact him through thelibertygroupofnevada.com.
