If you are planning on using the equity in your business to fund your retirement or your next adventure, you need to know the answer to ‘How much is your business worth?’
Are you like most owners of small private businesses (sales <$10 million/year) aiming to use the value locked up in your business to retire on?
If so you better know how much your business is worth.
Unfortunately it’s not like mutual funds or an equity portfolio where you can easily look up the stock price – there is no simple way of knowing if you have $500,000 or $2.5M locked in your business, it could be less or even more.
Having a realistic range, from the most you are ever likely to get, to the lowest ‘Fire Sale’ value, will help you decide on your timeline for retirement and if you want to do something to increase the bottom and top price range in your favor.
There are many ways to value smaller businesses. Some are simplistic others so complex and subjective as to be a academic exercise. Here are the most common, ranked from simple too hard:
- Multiple of gross income
- Multiple of net profit
- Multiple of EBTIDA (earnings before tax, interest, depreciation and amortization)
- Multiple of Sellers discretionary earnings (SDE) or owners free cash flow * most common
- Asset value – fire sale
- Discounted future cash flow (good for recurring income i.e. investment property portfolios)
Most accountants and business brokers use free cash flow. This is usually EBTIDA and add back the owners salary plus benefits, averaged over the past 3 years. The magic multiple is usually about 3. Why?
Because it’s historically been about 3. The range of 2-4 is often quoted. Personally I believe because at 4 the seller has hope and at 2 so does the buyer, bringing them to the negotiation table to settle at, you guessed it, around 3.
Now it’s not that simple. If you have real estate or significant investment in fixed assets, add the market value of these to the underlying valuation.
The difference in method could leave you significantly worse or better off.
Knowing your starting point gives you time to control the value in your favor.
What Impacts A Small Business Valuation
There are a number of key factors that can change the multiplier from 3 either up or down.
- Sales and profit trends
- Accuracy and credibility of historical Financial
- Industry sector and local economy
- Key employees and specialization
- Future growth opportunities and competition
- The quality of your internal controls and processes
- Opportunity for future efficiencies, cost reduction and leverage marketing and sales system
- Branding and digital footprint
- Housekeeping – clean, organized and well maintained assets and premises
- Supplier and customer contracts
- Reputation and repeat business new client s customer turnover and bad debt levels
Having a positive response to all of these could change the multiplier up to 6 or even 8. Imagine if your business could now be valued at double or more than the ‘standard’.
Wouldn’t you like to add 125% to your retirement fund?
The reality is, however, that what we value at is a starting point in negotiations with potential buyers and the final price is highly dependent on the sale terms. A 100% cash offer will be lower than a five-year, owner financed buy out.
How Long Does It Take To Prepare A Business For Sale
The longer you have to prepare your business for sale, the more likely you are to achieve a higher selling price. Having a succession plan that allows you 3 years to prepare is an ideal time scale. Preparing your business for sale in less than 12 months is possible but requires focus, determination, time and often the help of outside professionals .
About the Author Nick West is a chartered accountant, engineer and business consultant who has been helping entrepreneurs realize value by building and selling businesses since 1992.