What is a Business Worth?: 5 Things to Consider

Next to the decision to buy or sell a business, this is the toughest and sometimes the most emotional question: What is a business worth? There are five things to consider in valuating a business:

1. The Market Value of the Assets

2. Competitive Advantages of the Product or Service

3. The Goodwill of the Brand

4. The Diversity and Loyalty of the Customer Base

5. The Employee Profile

Each party to the transaction has its answer- not wholly based on the financial reports. For instance, the owner values what has been built while the buyer values what can be grown.

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The value to someone entering the business is different than that of a party already in it looking to expand market share or geography. A seller willing to hold a note from the buyer will usually get a higher price for sharing the buyer’s risk and providing an easier path to financing.

Of course, the financials are critical to the price to be paid. A buyer will require audited statements detailing cash flow, operating expenses, assets and liabilities, and profits. Also, the buyer will likely require up to three years of IRS returns. The structure of the deal (selling stock, assets, etc.) can affect the price. We will cover that in a future post.

In a previous blog (Are You A Small Business Owner?), I listed five non-financial aspects of a business that are critical to the price.

1. The Market Value of the Assets

What is the real estate worth today for its current use? Is the property better suited for a different (more valuable) use? These problematic questions make an appraisal or an estimate by a competent broker necessary. Are the building and equipment in good shape, or will significant capital expenditures be required in the near term? The more technologically up to date the equipment is will positively affect the price.

2. Competitive Advantages of the Product or Service

There are many aspects to your business’ profile in the marketplace. A couple of important ones are the growth profile and the competitive profile. The price you may receive will be significantly affected by whether the market for your products or services is growing, mature, or declining.

Your competitive profile is also critical to the value. A highly fragmented market can be an advantage if your business has unique characteristics that make it stand out. A more concentrated structure will put a premium on your position in it. Factors to be considered include location in relation to your customer base, product differentiation versus the competition, pricing, market share, and brand awareness. Do you have any patent, trademark, or proprietary protections?

3. The Goodwill of the Brand

We recently sold a business that was owned and operated by the seller for over 30 years. Several national franchises surrounded it. He had a loyal customer base (some multi-generations), which valued the more “personal” service versus the perception of the “impersonal” national firms. We will detail that story in a future post. This loyalty is “Goodwill.” Is your brand name well known, and does it have a reputation for quality and dependability?

4. The Diversity and Loyalty of the Customer Base

An analysis of the business using the 80/20 profile is important. That means do 80% of your sales and/or profits come from 20% of your customers or products. This can be a problem depending on how vulnerable they are to the competition. This is where customer loyalty is critical. The same profile can also mean there is room to grow the customer base. Also, if you are highly dependent on one supplier your supply chain risk may hurt valuation.

5. The Employee Profile

The experience, competence, and skill profile of management and labor are essential to future success. A critical issue is whether crucial personnel will stay on after the sale. In most cases, the seller does not want the employees to know the business is for sale. It’s vital that the broker you choose understands this and has a solid plan to market the business confidentially. We successfully did that in a recent sale mentioned above. There are situations where a bonus may be required to ensure continuity during the transition period after the sale. The labor market for the skills required is also a factor. The tighter the market, the harder it may be to retain critical employees. On the other hand, if your skilled workforce is likely to stay, it would be attractive to a buyer.

A tool used by many advisors is a “multiple.” It is a measure of sales or profits versus the price you are seeking for the business. A sales multiple of .5 means you are asking for $1 for every $2 of sales. All the factors presented here impact the likely multiple a buyer might find reasonable. Many sources of published multiples by industry are available, but they are general and can vary widely by geography and all the factors covered above. They are useful in measuring whether your price is out of line.

Placing the right valuation on a business is a tough task. A thorough analysis of the business can help create a mostly objective price—but there will always be some personal bias involved. That is why it is crucial to engage a team with the skills and experience to guide you to the right price. We are that team and are ready to help with valuation, even if you are not yet totally prepared to buy or sell?

Larry Montanus

Larry Montanus

Advisor & Business Broker

Meet the Expert

Larry has extensive business history, having held several senior executive positions. He was active in the citrus industry as president and COO of the publicly traded Orange-co Inc, and as Florida Citrus Operations Manager for Procter & Gamble. In total Larry spent 16 years at P&G. He was an Executive VP of Europe’s largest packaging company based in Paris. In that role, he was responsible for restructuring the company through a series of acquisitions and divestitures totaling almost $800 million.

Call Larry today at 863-812-4670 or email him at larry.montanus@svn.com.

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