Once upon a time, there was a little girl named Goldilocks. She went for a walk in the forest. Pretty soon, she came upon a house. She knocked and, when no one answered, she walked right in.
At the table in the kitchen, there were three bowls of porridge. Goldilocks was hungry, so she tasted the porridge from the first bowl.
“This porridge is too hot!” she exclaimed.
So she tasted the porridge from the second bowl.
“This porridge is too cold,” she said.
So then she tasted the last bowl of porridge.
“Ahhh, this porridge is just right,” she said happily and ate it all up.
When you are getting ready to retire and you want to sell your business, the process of valuing it can be a lot like Goldilocks’ porridge. Value it too low, and you won’t get what you deserve. Price it too high and you may get burned.
The trick is to value it just right, so that potential buyers will eat it all up.
The question of how to value your business can certainly be a tricky one; there are many numbers, facts, figures and variables at play. In addition, it’s often difficult to take an objective, factual look at your labor of love. The good news is that there are a few methods and rules that can make this process easier.
Earnings multiplication: This method is relatively straightforward and commonly used. In a nutshell, the idea is to multiply your business’s annual earnings by a multiplier. Let’s say your business has consistently made $100,000 each year, and there are no new factors that indicate any big changes in the foreseeable future. A business like this could sell up to 3-5 times its annual earnings, so you could value it anywhere from $300,000 to $500,000. Many businesses sell with multipliers in this range.
The problem here is that it can be tough to figure out the right multiplier; not only does it seem very subjective, but there are also plenty of variables (like hard assets, debts, accounts receivable, etc.) that are easy to overlook.
Be careful and scrupulous with this method.
Assets valuation: Instead of reducing your business’s value merely to its annual earnings, a different analysis sometimes used to determine value is simply adding up all your business’s tangible assets. These assets can be tools or equipment with potential resale value, contracts, receivables, etc. Once you add this number up and subtract debts you owe, you will come up with the net value of all your hard assets.
Although this method is more detailed, it can end up lowering the value of your business since it doesn’t take future income into account.
Comparables: This one is similar to the process you might go through to value your home. Here, you look at the value of other, comparable companies that have either a) been recently sold, or b) have, in one way or another, publicized their value.
The big flaw with this method might be obvious: There is almost always more than meets the eye. By assuming your company is comparable to another, you could be overlooking a whole gamut of variables, and thereby making a fatal apples-to-oranges comparison.
Professional valuation: To find out what your company is truly worth, the best thing you can do is hire a business broker and get a professional opinion. A complete valuation is a thorough evaluation and appraisal of your business – its assets, earnings, debts, future potential, etc. Anything you might accidentally overlook with your own quick valuation, a professional, complete valuation will make sure to account for.
Yes, this process is costly, but it’s also the most foolproof way to be sure you aren’t making a costly mistake, and that the bears won’t chase you out of your business. Taking the time to value your business for exactly what it’s worth will set you up for a sale you will feel confident in and won’t regret. Make sure to diligently research and weigh options so you know what is the best for your situation.
About Steve Strauss
Steven D. Strauss is one of the world's leading experts on small business and is a lawyer, writer, and speaker. The senior small business columnist for USA Today, his Ask an Expert column is one of the most highly-syndicated business columns in the country. He is the best-selling author of 17 books, including his latest, The Small Business Bible, now out in a completely updated third edition. You can also listen to his weekly podcast, Small Business Success.© Steven D. Strauss.
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