How much is my company worth? Entrepreneurs spend thousands of hours bringing an idea to life in the form of a small or medium size business. It takes years of hard work and dedication to build something out of nothing and business owners deserve a reward for their efforts, don’t they? The reality is that if you can’t sell your business, you don’t really have a business at all. You have a job. It might be a high-paying job, or one that let’s you choose your own hours and live your preferred lifestyle, but if you can’t sell it, it doesn’t hold any value.
Sounds harsh? It is. The value of your business is the price someone is willing to pay for it. Even if you don’t want to sell your business, it’s important to understand how to calculate its value. You never know what curveballs life may throw at you and you may find yourself in a situation where you need to cash out. This post is intended to show you how to place a value your small business and evaluate which factors go into its appraisal.
It’s important to keep in mind that we’re seeking the amount your business is worth to someone else who is looking to buy an existing business. It has literally nothing to do with how much your business is worth to you. However, buyers will always try to poke around your personal life to try to find out why your selling your business. Don’t let them. When negotiating the price of your business, leave your personal life out of it and focus on the facts about the company.
The most common way to value your business is through Earnings Multiples. For small and medium size enterprises with an established financial history, a fair way to determine its value is to take your net income and multiply it by a standard multiplier. This is also how publicly traded companies calculate their Price/Earnings Ratio: the value of a business divided by it’s post tax profits.
For example, if your company is making post-tax profits of $100,000 per year and someone offers to buy it for $500,000, your P/E would be a ratio of 5 and the value of your business remains equal to what someone is willing to pay, in this case $500k.
While the P/E is simple to calculate, finding a standard P/E multiplier for every business is an impossible task. Businesses that operate in industries like high tech and IT usually receive a much higher P/E ratio than more traditional brick and mortar companies like retail or restaurants.
So how do you find your earnings multiple? For the sake of simplicity, let’s imagine you own a service-oriented business without any inventory, big assets or liabilities. Here are 3 easy steps to calculate the value of a business:
1. Go Back In Time
Review your finances for the last 3 years and run some numbers. What was your net income and free cash flow? Has it been increasing or decreasing? If it’s been rising, be able to tell the story of what you’ve done differently than your competitors and how the new buyer can continue the trend moving forward. If it’s decreasing, you’ll need a convincing argument that the declining trend can be reversed.
If your cash flow and income is rising each year, you should be asking for at least 10 times the net earnings of the trailing 12-months. If your business earned $100k in 2014, you should be in the neighborhood of $1 million. On the flip side, if your returns have been in decline, you’ll have to lower your expectations due to an increased risk on the buyer’s side.
2. Reduce The Buyer’s Risk
Buying a new business can be a very risky endeavour and naturally, buyers are inclined to pay more if they perceive the risk of failure to be low. Find our as much as possible about the buyer and their professional history. Have they worked in your industry before? Do they have a trained team personnel is ready to handle the transition? Do they have relationships with key prospects that may lead to a big new contract? Each of these advantages bring more power to your side of the negotiation because they lower the buyer’s risk. By understanding your buyer’s agenda, you’ll be better prepared to receive as much value for your business as possible.
That isn’t saying you shouldn’t play fair. Honesty is the best policy and it’s against the law in most countries to not disclose impending problems within your business. If you oversell your position or compromise their due diligency, you could find yourself in court and lose everything.
3. Do Your Homework
The earnings multiple approach is far from an exact science, but it does provide a starting point for negotiations so do some research. What are other companies like yours selling for? Has there been any recent transactions of similar size and industry? Check out BizBuySell or eBay where others are selling their businesses. Contact a broker – a professional specialized in facilitating acquisitions and business transactions. They can often provide an unbaised appraisal much like a real estate agent.
The more prepared you are for selling your business the higher return you’ll receive when the time comes to part ways. Even if you don’t think you’ll ever sell it, it’s important to have a solid understanding of its worth on the open market. Be honest and keep your books in order. Above all else, find the right buyer. After all, one man’s trash is another man’s treasure.