How Do I Put a Price Tag on My Business?

by Mary Ramm

Here are three ways to understand your company’s true value.

Every business has a life cycle and, at some point, that cycle involves transitioning ownership to a new proprietor.

The wisest owners plan for their exit years before it happens. It typically takes nine months to sell a small business, depending on the economy, so preparation is critical.

One of the most common mistakes business owners make is not fully understanding the value of their company. Uninformed sellers often rely on anecdotal information, including what neighboring businesses or competitors recently sold for, or simply put their business on the market at the price they believe it’s worth.

Both of these strategies indicate a poor understanding of the valuation process and often result in disappointment or the realization that an exit is not possible at the desired time.

These are all reasons why it’s critically important to regularly value your business. Experts recommend having an independent valuation performed on your business prior to entering a sales process.

Because each market differs, there are no set-in-stone rules for determining the value of a business, but there are three key methodologies every business owner should utilize to determine an accurate value estimate for their company.

The Income Approach

Simplified, the income approach determines how much a buyer will pay based on the economic benefits of owning that business, which are determined by the cash flows it generates. These cash flows are defined as net operating income after tax, plus depreciation, less capital expenditures and working capital needs.

With this approach, the value of the business is determined by computing the present value of the forecasted future net cash flows over an appropriate period and the forecasted value of the business at the end of the period.

The Market Approach

The market approach determines the value of a business by comparing the company to similar businesses or securities of similar businesses that have sold (a stock buyout, for example). This approach will identify companies that participate in the same line of business and review what they recently sold for.

To use this approach, compare your company to others in the industries in which you operate. These companies should have a similar size, capital structure, profitability, growth prospects and risk factors.

With this approach, the most commonly used ratios are enterprise value to revenue and enterprise value to earnings before interest, taxes, depreciation and amortization.

The Asset Approach

The asset approach determines worth based on the value of the business’s individual assets and liabilities.

When using this approach, it’s important to understand each component of the business is valued separately. The values are totaled and reduced by outstanding liabilities to determine the net asset value of the company. Most commonly, the company’s balance sheet is adjusted to reflect differences between book value and known market values.

Whether you use the income, market or asset approach to valuate your business, remember there are several factors that can boost resulting value, including growth, profitability, size, lower volatility, synergies or interest rate environment.

Regardless of whether you plan to sell this year, in five years or somewhere further down the line, there is no better time than now to value your small business, create long-term strategy and ensure that when the time comes to exit, you will be financially stable.

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