Determining Your Company Value for Your Business Industry

You may reach the point in your entrepreneurial career where you want to determine the value of your company and the possible sale. The tool you will use to determine the value of your company is called the business valuation. The business valuation is the process and procedures used to determine what your business is worth. Determining the value of a business is difficult because value means different things to different individuals. Economic conditions, personal feelings, and historic value are all used to determine a business's worth. The businesses value is the expected price it would sell for. The actual price would be determined by who determined the value. And the ultimate sale price would be determined by how the business sale were conducted. A business valuation is conducted which determines the fair market value and ensures the evaluation principles are consistent, fair, and defendable in court. The fair market value is the value that a willing seller and a willing buyer would conduct the transaction if they were both informed of the relevant facts about the company. There are many reasons for business valuation including business sale, business expansion, bank financing preparation, partner buy-in, or possible divorce.

In a business valuation it is important to remember there are always two sides to the transaction a buyer and a seller and one of them always wants a higher valuation and one wants a lower valuation. Businesses differ in their size and business model, the markets they participate in, and their customers.

Every entrepreneur needs to know that valuation has many different meanings within the business world. It has more finite meanings from an accounting perspective but speaking purely as a business owner valuation is in the eye of the beholder and the definition will vary. The value of the business can be looked in several ways such as What is a business worth to an accountant using financial statements? What is it worth to a buyer? Valuation becomes even more complex for startups.

The information you need to begin the valuation process includes specific data about your company, data about your business industry an economic environment, and data are about your property's market. The amounts of a company's assets, liabilities, and equity, are determined by generally accepted accounting principles.

There are four business statements which you will need to develop your business valuation. These are:

  • Statement of cash flows, or statement of changes in financial position.

  • Balance sheet (statement of financial position).

  • Statement of stockholders' equity (or statement of partners' capital).

  • Income statement (statement of income, statement of operations, or statement of earnings).

  • There are many factors which can influence the business valuation including the length, type, and content of the business valuation report. The business valuation report will identify and describe the business of the valuation. The purpose of the valuation and the intended use of the valuation opinions and conclusions. The standard of value to be estimated. The extent of the valuation process and the assumptions and limiting conditions that affect the analyses, opinions, and conclusions.

When the valuation as complete you will review the business valuation report. Pay attention to the valuation methodology used. You will want to make sure the analyst correctly identified the property to be appraised. Ensure that your characteristics are fully captured in the report. Ensure the report is consistent and comprehensive. Make sure the report supports the conclusion you had hoped for as the business owner.

There are three common standards used in business valuation. These are fair market value, investment value, and intrinsic value. The fair market value is the amount a buyer would offer a business for sale and a seller would accept. The investment value as the value of a business to a real person ready to buy your business as opposed to the fair market value which is based on a hypothetical average. Intrinsic value is the value of true economic potential based on likely growth and operational strength.

There are three approaches for business valuation.

  • Asset Approach

  • Income Approach

  • Market Approach

Asset Approach

Using the asset approach, the value of the business is determined through calculations of the fair market value of its assets and subtracting any liabilities. Liabilities are any debts carried by the business such as accounts payable or loans.

This is the formula: Assets = liabilities + business owner's equity

The fair market value is determined for all aspects of the business both tangible and intangible. The law of supply and demand impacts the value of the business. A review is made of similar businesses in the area to develop a general idea of what the business is worth. Then the liquidation value is determined by calculating the value of all the assets of the building if they were to be sold. This includes equipment, land, property, facilities, furnishings and inventories. The income capitalization value may be determined by taking operating costs and expenses and projecting future income based on the past performance of the business. Once the two of these are determined you want to estimate the cash flow of the business. Cash flow is determined by taking the business earnings and adding any expenses, interest payments, and adding owner compensation. This will be an estimate of the cash flow of the business called the sellers discretionary cash flow. The seller of discretionary cash flow often referred to as SDCF by business brokers is calculated as follows:

Begin with the business pretax earnings

(+) Add the non-operating expenses

(-) Subtract the non-operating income

(+) Add one-time expenses

(-) Subtract non-recurring income

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(+) Add any depreciation or amortization expenses

(+) Add any interest expenses

(-) Subtract interest income

(+) Add the business owner's total compensation

Using the asset approach there are two calculations for asset based business valuation. These are the asset accumulation method which uses the typical business balance sheet and combines some of the tangible and intangible factors such as intellectual property, existing contracts, strategic agreements, tax obligations, and pending legal judgments. And the second method is the capitalized excess earnings method which determines the tangible assets and their intangible value. You begin the capitalized excess earnings method by listing the tangible business assets from existing financial statements and subtracting the liabilities from the assets. You will determine the business value by adding the net tangible value of the assets to the capitalized value of any excess earnings. Determine the business earnings which are related or attributed to the net tangible assets calculated by multiplying the assets times the rate of return which will equal a percentage. The final calculation would give you the excess earnings. The excess earnings are calculated as the difference between the total business earnings and the earnings that you can attribute to the net tangible assets. The difference between the total business earnings and the value can you can attribute to the net tangible assets is called the "goodwill" of the company.

The equation for this Business Value = Assets + Business Goodwill

The asset accumulation method determines the business assets and subtracts the liabilities to arrive at the business value.

Using the income approach, the value of the business is determined through the businesses ability to generate income for the owners. The income approach method determines the businesses value as a function of the economic benefit or the income it produces for the owner. In order to calculate the income approach you will use the capitalization rate, discount rate and valuation multiples. The capitalization rate is a number used to take a single business point and convert it into a business value. The capitalization rate and discount rates are similar. The discount rate is the required rate of return to make a business acquisition viable or productive. So the capitalization rate is a divisor and the valuation multiple is a multiplier. The valuation multiple is a number used to take a single business to benefit and convert it into business value.

The income approach uses three methods. These three methods are the discounted cash flow method, capitalization of earnings method, and a multiple of discretionary earnings method. The discounted cash flow method is used to calculate a business value by using the net cash flow, the discount rate, and expected gain from the sale. This is the preferred method of business valuation professionals because of the financial the theory backing. The capitalization of earnings method determines business value using a single measure of the expected business benefit divided by the capitalization rate. The multiple of discretionary earnings method establish the business value as a multiple of an economic benefit. The multiple of discretionary earnings method calculates the business value by multiplying the seller's discretionary cash flow shown earlier by an established valuation multiple that is based on benchmarking from similar businesses or industries. This benchmarking may include these financial and operational components: earnings records, industry growth, location, competition, business growth prospects, business type, buyer desirability factors, ease of operation, number of employees, product or service mix, market saturation rate, and management qualities.

Using the market approach, the business value is calculated compared to the historic sales of similar businesses. In order to determine the value of your business you have to evaluate your market. This includes the size of the market, the growth in your area, the position you hold within your area, your market saturation rate, your company's growth and your business location. The two most common methods used under the market approach are the Comparative transaction method and the publicly traded company method. These methods use sales of similar businesses to statistically develop a business price. The analysis forms the market comps which are the sales of comparable businesses in your area.

Market-based business valuation methods use both the publicly traded company method and the comparative transaction method. Both methods compare the business being valued to similar companies.

Here are a few concepts that may affect the value of your company during a valuation.

  • You are the single individual involved in the company and its success relies solely on your personality, network and contacts.

  • You have revenue that you do not control such as a licensing agreement

  • You have too few customers and a large percentage of your business is built on them

  • You have too few suppliers for the required materials to run your business

  • You have too many of your aspects tied to a single individual in a company so that if you use the contact your business is in trouble.

  • Market saturation

  • The depth of your management

  • Market position

  • The amount of revenue you generate

  • Operating history

  • Amount of debt you have taken on

Sellers are often frustrated when their business value does not meet their expectations. There are steps you can take to increase the value prior to your sale. These include documenting your track record of profits and positive cash flow and identify the advantages your business has in the marketplace. Create seamless processes in order to convince buyers they can successfully operate the business. Highlight the skilled employees that bring stability to the business and generate revenue. You also want to highlight your recurring revenue showing that you have a strong customer base and established customer loyalty. Organize your business to include all paper documentation such as policies or financial records. Clean all of your facilities. The visual appeal to your business will help it sell. Prospective buyers want a move in ready business which shows simplistic operation, organization, and is something they can envision themselves managing. You must provide them with this vision by asking them where do you see your business five years down the road? You may even provide some level of seller financing to improve your chance for sales.

Selling your company

If you know the value of your business and decide to sell all of your hard work here are the key bits you should know and steps you should take.

  • Set your price range based on the value you have determined.

  • Prepare your property, equipment, and furnishings for the sale. You should clean up any dirty areas, organize items, and trim the grass on your property. If buildings need minor repairs make them.

  • Seek out potential buyers for your business which may include advertising or using a real estate agent.

  • Negotiate a deal with a respected buyer and hopefully their offer is in alignment with the evaluation you made for your company.

  • Both parties sign a sales agreement for your sale price.

  • Plan for your business closing which means turn over the keys, customer contacts, and other items you no longer need for the business but the new owner will.

  • Once this is complete you will need to pay the necessary taxes.

In order to prepare for the sale you or your agent will want to bring any sales documents, required tax forms, insurance documentation, contract transfer documents, the list of accounts receivable and accounts payable, the transfer of any building leases, and the exceptions to warranties or exceptions. When you close on your sale want to make sure you address these items.

  • The adjusted purchase price of the time the sale of any prorated cost such as utilities

  • Completion of the IRS Form 8594 Asset Acquisition Statement

  • The closing sheet or someone sheet

  • A bill of sale for the business

  • Any lease agreements

In order to sell your business officially, you will need to prepare a sales agreement. It is important to make sure the agreement is accurate and contains all the terms of the purchase. The agreement should define everything that you intend to sell with the business including, assets, intellectual property, existing customer lists, and goodwill.

These items should be addressed in the agreement: the date of closing, any representation and warranties of the seller and buyer, the names of the seller, buyer, and business, business background information, any contingencies, the assets being sold, the purchase price and Allocation of Assets, any fees including brokers fees, any adjustments to be made, how the business will run prior to closing, the terms of the agreement, payment terms, and a list of inventory included in the sale.

Be sure to celebrate this is time to move on to the next venture.

Summary Reminders and Takeaways

There are several models and methodologies to value your business. The important thing to remember is that you have one price in your mind and the buyer has another. It is likely your asking price is higher than their offering price. That is a simple principle of buying and selling. Everyone wants to buy low and sell high. Placing a value on your business is a difficult endeavor and a good approach is to use a number of business valuation methods. Often the best and most accurate price for your business will be derived from combining the results of several business valuation methods. The three approaches for business valuation include the asset approach, the income approach, and the market approach.

The key points when valuating your business.

1) Examine your assets. Think about all of the tangible things you own of value in your business. Equipment, furniture, and furnishings within your building. These are all things a new business would have to acquire to begin serving customers so they have a value. Take your assets and subtract your liabilities to determine a rough estimate of business worth.

2) Evaluate your earnings in terms of your annual profit. It is possible to produce a high annual revenue without making a profit.

Don't forget your intangible measures that are based on individual concerns and priorities. In some cases intangible assets can end up being just as important to your business's value as its monetary worth.