Calculating your business' worth can be done in three ways
The first looks at your company's assets; the second examines the prices of similar businesses; and the third looks at cash flow. In the first case, a business appraiser will examine your business' hard assets, including machinery, equipment, or real estate. Your business value is basically the sum of these assets minus any liabilities. Businesses that are looking to sell quickly or that are not very established may prefer this method; otherwise, depending on your industry, you're likely to lose some extra cash, as you are not factoring in the future earning potential of the company.
A second valuation technique relies on sales of similar businesses in your area. "The value drivers for smaller companies are very different from the stock market, so focusing on private transactions is the only comparable way to feel out the market," says Michele Miles, executive director of the IBA in Plantation, Fla. Appraisers will comb through databases of sales such as the IBA's Transaction Database, which lists some 30,000 deals nationwide. The Risk Management Assn. compiles and analyzes bank loan data for commercial sales. With this method, the location of your business plays a big role. A technology firm in New York or Silicon Valley, for example, will likely have a higher value than one located in a rural area. This method does have limitations: It doesn't account for things that may make your company more valuable than one across town that produces a similar product, such as a strong management team or sales process.
You may be able to take a more accurate measure, however, by using a more complex multiyear projection of cash flow, called a discounted cash flow. Appraisers will factor in a discount rate, referred to as the buildup discount rate, which accounts for risk. This rate is usually inverse to the cash flow and includes such things as the growth rate of your particular industry and hazards associated with your specific company.
Some risk factors: Is one person so involved in the business that his or her departure would harm it? Do you have only a few customers who make up the bulk of your revenues? "The smaller the company, the greater the risk associated and the greater the return required by an investor," says Kennedy. If, say, a company has $400,000 in cash after taxes and expenses and a discount rate of 20%, its present value would be $2 million, which is the cash flow divided by the discount rate. Small businesses typically sell for roughly 60% to 70% of revenues, according to the IBA.
Late in 2007, a local competitor asked Butch Platt, president and owner of Phoenix-based Lithotech, about a merger. After 30 years in business, Lithotech, an offset printing and graphics company with 52 employees and $7 million in sales, was debt-free but somewhat behind the curve upgrading its equipment.
The company that approached him was in the reverse position. "They had the equipment, but I had the financial wherewithal," says Platt. Both companies hired appraisers. About 2 1/2 months and $3,500 later, Platt discovered that his business was worth $5 million. Although he says he is still awaiting the results from the other company, Platt is now in a much better position to negotiate. Says Platt: "This will tell me exactly what my share of the stock will be." And there is nothing sentimental about that.
The first looks at your company's assets; the second examines the prices of similar businesses; and the third looks at cash flow. In the first case, a business appraiser will examine your business' hard assets, including machinery, equipment, or real estate. Your business value is basically the sum of these assets minus any liabilities. Businesses that are looking to sell quickly or that are not very established may prefer this method; otherwise, depending on your industry, you're likely to lose some extra cash, as you are not factoring in the future earning potential of the company.
A second valuation technique relies on sales of similar businesses in your area. "The value drivers for smaller companies are very different from the stock market, so focusing on private transactions is the only comparable way to feel out the market," says Michele Miles, executive director of the IBA in Plantation, Fla. Appraisers will comb through databases of sales such as the IBA's Transaction Database, which lists some 30,000 deals nationwide. The Risk Management Assn. compiles and analyzes bank loan data for commercial sales. With this method, the location of your business plays a big role. A technology firm in New York or Silicon Valley, for example, will likely have a higher value than one located in a rural area. This method does have limitations: It doesn't account for things that may make your company more valuable than one across town that produces a similar product, such as a strong management team or sales process.
CASH-FLOW ACCOUNTING
A more thorough approach, and the most common, is the cash-flow method. The easiest way to do this is to tally cash flow minus expenses. This number represents what a new owner could make free and clear during his first year. If you have a startup or a very small company, the process is straightforward enough that you could do it on your own.You may be able to take a more accurate measure, however, by using a more complex multiyear projection of cash flow, called a discounted cash flow. Appraisers will factor in a discount rate, referred to as the buildup discount rate, which accounts for risk. This rate is usually inverse to the cash flow and includes such things as the growth rate of your particular industry and hazards associated with your specific company.
Some risk factors: Is one person so involved in the business that his or her departure would harm it? Do you have only a few customers who make up the bulk of your revenues? "The smaller the company, the greater the risk associated and the greater the return required by an investor," says Kennedy. If, say, a company has $400,000 in cash after taxes and expenses and a discount rate of 20%, its present value would be $2 million, which is the cash flow divided by the discount rate. Small businesses typically sell for roughly 60% to 70% of revenues, according to the IBA.
Late in 2007, a local competitor asked Butch Platt, president and owner of Phoenix-based Lithotech, about a merger. After 30 years in business, Lithotech, an offset printing and graphics company with 52 employees and $7 million in sales, was debt-free but somewhat behind the curve upgrading its equipment.
The company that approached him was in the reverse position. "They had the equipment, but I had the financial wherewithal," says Platt. Both companies hired appraisers. About 2 1/2 months and $3,500 later, Platt discovered that his business was worth $5 million. Although he says he is still awaiting the results from the other company, Platt is now in a much better position to negotiate. Says Platt: "This will tell me exactly what my share of the stock will be." And there is nothing sentimental about that.
