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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5 Numbers That Can Predict the Perfect Time to Sell Your Company

By John Warrillow Founder, The Value Builder System

There's a downside to timing the sale of your company on the basis of external factors. An alternative approach may leave you with a lot more money in your pocket. 

Do you feel a little richer this month? You should. The value of your business just went up.

Since 2012, my team at Sellability Score has been analyzing offers entrepreneurs have received to buy their businesses. Every quarter, we look at the average multiple offered, and it is now at its highest point since we started tracking offer multiples.

For the most recent quarter, ending June 30, 2014, the average offer received was four times pretax profit (offers were much higher in some industries and among businesses with certain attributes), or about 10 percent higher than the average multiple offered lifetime of 3.66 times pretax profit.

When the value of your largest asset jumps by 10 percent, it may be tempting to hurry and get your business on the market. After all, isn't it better to buy low and sell high?

The Downside of Selling at the Peak

The thing many of us forget is that when you sell your company--possibly your largest asset and the biggest wealth-creating event of a lifetime--you have to do something with the money you make.

These days, that means you'll have to turn around and invest your windfall into an asset class that is equally bubbly. The stock market has more than doubled since 2009. The price of residential real estate has been growing at a rate of 1 percent per month in many major centers. The same trend can be seen in many markets that offer exclusive beach houses or ski chalets.

Who Is Richer: Samantha or Scott?

Indulge me in a hypothetical example. Let's look at two imaginary business owners, each running a company generating a pretax profit of $500,000. Let's imagine that Samantha sold her business back in 2009 for three times her pretax profit. She would have walked with $1.5 million pretax to invest in the stock market.

Now let's imagine business owner Scott, who decides to try and time the market. Scott waited out the recession and sold his business last month for four times pretax profit, walking away with $2 million before deal costs. At first glance, Scott looks like the winner because he sold at the peak and got four times profit instead of Samantha's three times. But when we take a closer look, Samantha would probably be better off today. Assuming she had invested her $1.5 million in the stock market back in 2009, when the Dow was trading below 7,000 points, she would now have more than $3 million, or a third more than Scott, who waited and sold at the "peak."

Timing the sale of your business on the basis of external markets is often a zero-sum game, because unless you're going to hide the proceeds of a sale under your mattress, you're probably buying into the same market conditions from which you're selling out.

Time Your Sale on Internal (Not External) Metrics

The alternative is to time the sale of your business on the basis of internal metrics, rather than external factors. Waiting until you have your business optimized according to the dimensions business buyers care about will ensure you get the highest price that businesses like yours are fetching at the time you are selling. Here is a partial list of metrics acquirers care about most:

1. Revenue Growth: The larger and faster-growing your business, the more attractive it will be to a buyer.

2. Gross Margin Growth: Maintaining and increasing your gross margin (the difference between the price of your product and the costs of acquiring the raw materials to make it) indicates to a buyer you have a differentiated value proposition that enables you to control your pricing.

3. Sales Per Employee: Illustrates how dependent you are on people to make a profit and how efficiently you translate talent into profit. This number will vary according to the industry but, like most numbers, bigger is better in the eyes of an acquirer.

4. Sale Per Square Foot: Illustrates how efficiently you use commercial space. Critical among retailers, it can also help an acquirer understand how efficiently a business in any industry uses real estate.

5. Customer Acquisition Cost: Take the total of your sales and marketing expenses in a given time period (e.g., a month) and divide it by the number of customers acquired in the same period. This helps an acquirer understand the capital required to scale your business.

Once you start optimizing your internal numbers, you can sell your business for whatever the market is paying at that time for businesses like yours. Then you can turn around and invest the proceeds into the same market conditions--whatever they may be.

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HOW-TO: SELL A BUSINESS

Exit Strategy: You need a solid blueprint 

Being a business valuation expert and consultant for the past 20 years has given me the opportunity to explore with various business owners in Central Texas the important elements of exit-planning strategies.

Not every business owner takes that important step to weigh all of the options to make a well-informed decision.

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IMAGE PROVIDED BY THINKSTOCK

(MARCUS LINDSTR)

According to the Center for Women’s Business Research, approximately 80 percent of small business owners start planning an exit strategy when they are considering retirement.

Yet it’s important to think of exit planning as a blueprint for getting to the point of the sale transaction: You wouldn’t start building a house without having a blueprint, nor would you base your business exit strategy on the day you want to retire.

In most cases, there are five ways to exit your business:

• A straight sale. Selling a business to a third party is the most common form.

• Employee purchase. Transfer of ownership to one or more members of the management team who you have developed over the years.

• Family ownership transfer. Ownership transfer to one or more family members or relatives.

• Sell directly to another business. Businesses often buy other businesses for a method of quick expansion.

• Liquidation. The owner closes the company and sells the fixed assets to the highest bidder. Generally, the company needs valuable equipment and/or land so that the creditors can be paid first.

Estimate value

One of the first things to do is estimate the value of your company. It should include setting the baseline as to how your company compares to similar companies in your industry. By speaking with professionals that do sell-side transactions, the owners will be able to get a sense of the market value of the company.

Depending on the size of your business, a formal valuation by the business valuation expert or business broker is needed when you get ready to sell your company. Many of the steps in developing a formal business valuation can boost your company’s worth by uncovering some hidden value not considered in an initial estimate.

Three common ways a valuation expert will value the business is by using one or a combination of the asset, income and market approaches. Taking into account income, the valuation expert analyzes the benefit stream of the company, or cash flow, and divides that by the capitalization rate to provide a net present value of the business. The market approach compares your company to the same or similar companies that are the same size, in similar geographical areas and industry.

The business owner should also seek out a team of experienced professionals such as a transactional lawyer, accountant/tax adviser, business broker and business appraiser who will work together to execute the exit. A smaller business sale is often advised only by a lawyer and accountant. Good advisers will bring professionalism to the transaction process and in all likelihood will have a positive effect on the deal.

Business owners want to get as much as possible from the sale. That is why pre-sale restructuring becomes an effective tool in maximizing the price. If you feel that you have maximized your profits, consider hiring an outside third party such as a business consultant or your CPA to review your books and make suggestions.

To boost the sale price, grow your revenue. Consistent growth will stimulate interest in the sale. If possible, structure your company so your top managers or employees are efficiently running the operation on a day-to-day basis.

Finally, be aware that timing your exit is everything in the sale of your business. In a multi-year business cycle there will be a few occasions where the company will be at its highest valuation. As a general rule it will be at the highest value when the equity markets are at their best — like right now.

So if your company’s life cycle is approaching maturity and your own personal objectives are in alignment, perhaps it’s time to gather your team and consider your exit strategy.

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By: Noel StoutPresident of Stout-Associates