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        Small Business Valuation : What is Your Business Really Worth?

        Another AHBBO Article
        Cashing Out ... What is Your Business REALLY Worth?

        © 2013 Elena Fawkner

        Question: What is your business REALLY worth?
        Answer: Whatever someone else is willing to pay for it at the time.

        That's a true statement as far as it goes but it doesn't take into
        account that the way you arrive at a value for your business can
        give you much-needed ammunition when it comes to justifying
        your asking price and therefore allow you to influence what the
        prospective purchaser is willing to pay.

        Here's a quick primer of the various methodologies commonly
        used for valuing businesses (for purposes of imminent sale or

        1.  Asset Valuation

        This is used by businesses with predominantly physical assets,
        especially inventory.  Typical businesses that would use this
        approach are manufacturing and retail.  The valuation takes into
        account the following figures: (a) the fair market value of fixed
        assets and equipment; (b) the value of leasehold improvements;
        (c) owner benefit (the seller's discretionary cash for one year -
        comes from the adjusted income statement); and (d) inventory.

        2.  Capitalization of Income Valuation

        This is used by businesses with predominantly intangible assets.
        It places no value on physical assets, only intangibles.  Typically
        used by service businesses.  Under this method, various factors
        are given a weighting of 0-5 with 5 being the most positive score.
        The average of these factors yields the "capitalization rate" which
        is then multiplied by the buyer's discretionary cash (75% of the
        owner benefit defined in 1. above) to arrive at the market value of the
        business.  The factors to be rated are: (a) owner's reason for selling;
        (b) length of time the company has been in business; (c) length of
        time the current owner has owned the business; (d) the degree of
        risk; (e) profitability; (f) location; (g) growth history; (h) competition;
        (i) barriers to entry; (j) future industry potential; (k) customer base;
        and (l) technology.

        3.  Capitalized Earnings

        This method is based on the rate of return anticipated by the
        investor.  Small businesses are expected to have a rate of return
        of 20-25%.  So, if your small business has expected earnings of
        $10,000 for the year, its value may be $40,000 - $50,000.

        4.  Cash Flow

        This method is simply based on how much of a loan the purchaser
        could get based on the adjusted cash flow of the business.  The
        adjustments to cash flow are for amortization, depreciation and
        equipment replacement.  Obviously, when using this method, the
        value of the business fluctuates with changing interest rates.

        5.  Discounted Cash Flow

        This method discounts the business's projected earnings to adjust
        for real growth, inflation and risk.  It calculates the value today (i.e.,
        discounted for time) of the business's future earnings.

        6.  Leapfrog Start-up

        This is used when the buyer wants to save him or herself the
        cost, time and effort of ramping up a new business.  The buyer
        estimates what it would have cost to do the startup less what is
        missing plus a premium for saved time.  The more difficult, expensive
        or time consuming the start-up would otherwise be, the higher the
        value that will be arrived at using this method.

        7. Excess Earning Method

        Similar to the capitalized earnings approach, but the return on assets
        is separated from other earnings which are deemed "excess" earnings
        generated.  The return on assets is usually determined by industry

        8.  Owner Benefit Valuation

        This method is based on the seller's discretionary cash flow.  It is
        usually used for businesses whose value comes from its ability to
        generate cash flow and profit.  The formula is to simply multiply the
        the owner benefit by 2.2727.

        9.  Rule of Thumb Methods

        These are rough guides based on industry averages.  Many industry
        organizations have developed methods for their particular industries.
        They are highly unscientific and hardly rigorous but act as a good
        "gut-check".  You certainly wouldn't use them on their own but they
        can be useful to check that the value you've arrived at using a more
        scientific approach is in the ballpark.

        10. Tangible Assets (Balance Sheet)

        This method is basically a value of the business's current assets and
        nothing else.  Typically used where the business is losing money.
        This approach will usually be utilized when selling the business is
        just a matter of getting the best possible price for the equipment,
        inventory and other assets of the business.  A good strategy is to
        approach other firms in the same business that would have a direct
        use for such assets.

        11.  Multiple of Earnings

        A multiple of the cash flow of the business is used to calculate its

        12.  Value of Specific Intangible Assets

        The value of the business is based on how much it would have cost
        the buyer to generate the intangible asset.  Typically used where
        specific intangible assets that come with the business are highly
        valuable such as a customer base.  Customers with a high
        likelihood of being retained are valuable in most industries.

        The most appropriate valuation method for you depends very much
        on the nature of your business.  If you manufacture widgets, for
        example, you'll want to use the asset valuation method.  If you offer
        website design services, on the other hand, you'll want to use the
        capitalization of income method instead.  If you're selling a web-
        based business where the major asset is your high traffic volume
        and/or list of ezine subscribers, you will probably want to use the
        value of specific intangible assets method, such as 10 cents
        per subscriber (or whatever the going rate is).

        Is more than one valuation method applicable to your business?
        If so, calculate the value of your business in accordance with
        all of them and see which gives the best result (i.e., highest
        value).  Another good approach is to average your calculations
        to get a reasonable ballpark figure.

        Whichever method you choose, understand it inside out so
        that when the time comes, you can authoritatively justify your
        asking price to potential buyers.  Pulling a figure out of thin air
        without any substantiation whatsoever is much less impressive
        than being able to say, with confidence, "I worked with my
        advisers using a number of different methodologies to value the
        business. We adopted the value of  specific intangibles method
        because the backbone of the business is our large, loyal ezine
        subscriber database.  We also calculated it on the basis of
        capitalization of income, which yielded a similar value.  I can
        show you the calculations if it will help you see where the number
        comes from." 

        By following this approach you may not necessarily get the
        value you are after (for this reason, many sellers artificially
        inflate their asking price so they have room to be negotiated
        down), but at least you have a solid starting point for
        negotiations and are much more likely to be able to negotiate
        a price both buyer and seller are able to live with.


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        ** Reprinting of this article is welcome! **
        This article may be freely reproduced provided that: (1) you
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        Elena Fawkner is editor of Home-Based Business Online. Best business ideas and opportunities for your home-based or online business.

        Copyright 1998-2017, AHBBO.com. All rights are reserved. Tuesday, 26-Jan-2021 03:06:55 CST