How to value a small business
If you’re buying or selling a small business, it’s critical to know what the business is worth. The challenge is that what you think a business is worth, and what the person on the other side of the fence thinks it is worth, are
usually two different figures.
In the end, the motivation for both buyers and sellers is always the belief that they’re getting a good deal.
If you’re selling your business, you’re likely to be disappointed if buyers don’t see the potential you do. For example, a café up for sale at $300,000 included a purpose-built wooden floor with the café’s name etched in the middle. The floor alone cost $100,000 – but nobody else saw any value in the floor.
The worth of a business hinges on how much profit it will make, balanced by the risks involved. But past cash flow, profitability, and asset values are only the starting points. It’s often the hard-to-measure factors such as key
business relationships and goodwill that provide the most value.
Factors influencing value
There are four basic criteria that affect the value of your business.
The reasons for selling a business can affect its value. For example, a forced sale is likely to drive down the value. An owner-manager forced to sell by ill health may have to accept the first offer that comes along.
If you’re closing a business, its value will be the sum of its realizable assets, less its liabilities. Often the longer you have to sell, the better the price you’re likely to receive.
How tangible are the business’s assets? A business that owns property, machinery, or stock-in-hand has tangible assets that will have some resale value. This makes the business easier to value.
Many businesses have almost no tangible assets beyond office equipment; however, their intangible assets may have significant value. Some examples are a well-respected brand, customer goodwill, intellectual property (such as patents or protected designs), and potential for growth. These intangibles can be harder to value. Your business banker or accountant may be able to give you guidance with these.
Length of time
The longer the business has been operating, the better, because it will have a proven track record and cash flow, and possibly loyal customers who provide repeat business.
Be wary of young businesses for sale (between one and two years), as they may be experiencing current popularity (like bars and cafés can do) before the market turns away.