Before we get into how business valuation works, and how you can achieve a higher valuation for your business, there is a simple fact that must engraved in our minds: A business is worth whatever someone is willing to pay for it. Too often we get so caught up in the theory and the process and we forget a sale is about two minds coming together and making a deal.
There are ways to increase the value of your business – just as a garden full of flowers and a fresh coat of paint may increase a house price. You can renovate your business and make it more attractive to a buyer and take steps to increase EBIT and sell your business at a higher price.
So, pause for a minute and think about how you could make a handful of changes that could result in a fistful of dollars.
There are numerous theories on how to value a business. While some can be extremely complex and can send you into abacus meltdown, many apply a rule of thumb and use EBIT to value a business.
It is common for a small business to be valued as a multiple of its current profits. If you have a well-established business with strong profits and a solid market position then you may be valued at 8 to 10 times current profits.
A less established business with more competition, fewer physical assets or a greater dependence on a few key employees may be valued at two to four times current profits. EBIT is often the profit measure used and there are ways to improve your EBIT.
You can use last year’s profit, the current year’s profit or an average over the last two or three years. That really comes down to horse trading and the case you can make for whatever period you base your calculations on. Other factors that will also usually be taken into considerations are the tangible and intangible assets of the business.
Tangible assets can be valued by considering:
- Inventory and supplies;
- Equipment values based on remaining useful life and its depreciation value; and
- Land or building value – best appraised by a local real estate valuer as physical location will always be a crucial factor.
Research shows that even professional appraisers sometimes differ up to 30 percent in the value they set for a business. A lot of this variability comes down to the value attributed to intangible assets such as goodwill or other difficult to measure assets. Goodwill is awkward to value as it is so subjective to assess the market reputation of a business or its ability to engage new customers.
The people who work for a business are often some of its greatest assets. It could take years to retrain someone to the same level of market knowledge, competency or sales networks. The worth of the human resources that comprise a business is often taken into serious consideration when determining the purchase price of a business. Strong management or highly skilled staff may increase the valuation. Of course, this has to be balanced with the reality that these employees may leave and that risk must be factored into the price paid.
Setting the Price
If you are the seller, once the valuation is calculated you may wish to add a bit of fat to the figure so you have the ability to negotiate. Of course, your ability to set the price will be determined by your need to sell. A quick sale may require a price reduction while patience may mean a premium can be achieved. Despite all the factors listed above, one reality remains, the final price will likely be determined by your horse trading ability and your ability to convince the buyer of the future prospects.