by Guest Author on March 6, 2013
This is one of the classic questions in all of business – how much is your business worth?
Whether it’s baseball cards, comic books, or your business, it is only worth as much as someone is willing to pay you for it. That’s great if you’re a parent who wants to toss your kid’s comic book collection. It’s terrible if you’re a business owner who is pondering whether you should sell your business. It’s even worse if you’re a business owner looking to secure a loan and need an accurate valuation in order to do so.
Today, we’ll discuss our approach in appraising a business and it’s one that we’ve developed with the help of a former private equity analyst. It’s an extremely data driven process, which helps us establish a more accurate range, but the approach is valuable even without the data behind it. Our hope is that by understanding the process, you can execute it yourself or use it as a basis for evaluating a professional business appraiser.
How to Value Your Business
The simplest way to determine the value of your business is to calculate your earnings, most commonly referred to as EBITDA (earnings before interest, taxes, depreciation, amortization), and then multiple it by a “comparable multiple” figure for your type of business and the industry you operate in.
Step 1: Calculate your EBITDA
Calculating your earnings is as simple as taking your revenue and subtracting your expenses. You can make normalizing adjustments for items you feel are one-time income or expense items or adjusting figures to be closer to market rates, such as salaries. The key in this phase is to get an accurate picture of your business. If you have figures that need adjusting because you made decisions for tax reasons, such as accelerating expenses or deferring income, you want to make sure that those decisions are normalized.
The one-time income and expense item adjustment is worth discussing in greater detail because a lot of businesses rely heavily on the owner’s involvement. For example, a one-person consultancy firm will be a much harder sell than a ten-person firm. Or a fifty person firm. With a smaller company, your involvement, your network, and your personal brand will be a significant driver of your revenues and any potential buyer will recognize this.
If you’re doing a valuation just for personal reasons, or for a loan, this isn’t a significant issue. If you are doing a valuation for the purposes of selling your business, you need to be aware that a buyer will discount your revenues because of this fact. You can mitigate this by offering to sign an employment contract, that keeps you with the business for a set period of time, or a covenant not to compete, to prevent you from starting up the same consultancy, but even then the revenues will have to be discounted.
Step 2: Determining Your Multiple
As I mentioned earlier on our data driven process, the data helps us hone in on a more accurate multiple figure but when you consider that your business’s value is in what someone will pay, this accuracy doesn’t necessarily give us a significant advantage. It’s nice to be more accurate but in the end the price tag will be in the hands of the buyer, not a spreadsheet.
That said, how do you determine an accurate multiple? Unfortunately, this is the trickiest part and one that will require you to simply ask around and do your own research. Some industries publish this type of information in industry publications while others keep this data close to the vest. If you know other entrepreneurs with similar businesses, ask them if they know what the typical going rate is for your business.
If you are getting a valuation for a loan, ask the bank. In the case of a loan, the bank will likely do their own appraisal if they are willing to use your business to secure it. Unfortunately, they typically will demand a personal guarantee and more significant collateral, such as your home. In the event you default, banks are better at selling homes than businesses.
If you don’t know anyone who is selling a business like yours, it’s time to start checking the classifieds, online business sales sites, and any public marketplace where businesses are bought and sold. There are a surprising number of these types of sites and they can give you enough information to get a ballpark estimate.
If you are still having problems, please reach out to us and we’d be happy to help.
About the Author:
Jim Wang is one of the founders of Plan for the Sale, an educational website that teaches business owners everything they need to know to sell their business. He got his start with Bargaineering, a popular personal finance blog that has been featured in the New York Times, Baltimore Sun, and U.S. News and World Reports. As a former cog in the corporate defense industry, he’s always eager to chat with fellow entrepreneurs and those seeking to escape. You can connect with Jim via LinkedIn.