What is your business worth?
A client of ours was approached recently with an offer to buy out part of their business (their business is structured with 2 distinct parts to it, so this is a possibility for them). At this point, it’s impossible to tell if it’s a legitimate offer that will hold up or just a fleeting thought that was thrown out there.
But… it did spur a lot of questions and some serious thinking. Questions like:
Would they be willing to sell that part of their business?
What’s the business worth? What would they be willing to take for it?
What’s the impact on the remaining part of the business?
Should they instead look for a different kind of buyer (one who might buy the entire business)?
What do they really want to achieve with their business? Or what’s next if they do sell?
Of course, the answer to many of these questions is really dependent on how much they could sell for. Almost everyone would sell their business if the price was high enough but generally, businesses are rarely worth what the owners think it should be worth.
How do you value your business (or even a part of it)?
There are several different ways to value a business – inventory, and equipment heavy businesses might use more of a ‘book value’ approach based on a calculation of Assets minus the Liabilities owned by the business. However, most smaller service-based businesses will be more accurately valued as a multiple of their earnings. Here’s a great overview of a simple valuation approach that I found on the Business Town website – Bob Adam’s Simple Valuation Guidelines (*Note – I don’t know who Bob Adam is, but I like his guidelines…). 😉
A Simple and Fast way to think about Valuation
This method is based on a multiple of earnings (or pre-tax profits) and works best for a service based business that has revenue in the $100,000 to $2M range. However, directionally it would work for larger businesses – with larger mid-market companies typically getting a multiple of 5X to 7X earnings (or technically EBITDA).
Bob Adams’s Simple Valuation Guidelines
- An extremely well-established and steady business with a rock-solid market position, whose continued earnings will not be dependent upon a strong management team: a multiple of 8 to 10 times current profits.
- An established business with a good market position, with some competitive pressures and some swings in earnings, requiring continual management attention: a multiple of five to seven times current profits.
- An established business with no significant competitive advantages, stiff competition, few hard assets, and heavy dependency upon management’s skills for success: a multiple of two to four times current profits.
- A small, personal service business where the new owner will be the only, or one of the only, professional service providers: a multiple of one time current profits.
A few things to consider with these guidelines: For starters, these are listed in reverse order of how common they are. Very few businesses will command an 8 to 10 times multiple, in fact, there’s not a lot that will get the 5 to 7 times multiple. These numbers line up fairly closely with the statistics that we’ve seen with the Value Builder Assessment (which has now been taken by over 30,000 businesses). As you can see from the chart below – the top-scoring businesses (at a score of 80+) average an offer to buy that’s 6.27 time their profits. But it is very difficult to legitimately score an 80 – the average score is just over 50.
Strategic or Financial?
Another big driver for potential valuation is whether your business is a strategic acquisition or a financial transaction. If there’s no particular strategic synergy with the buyer, it will likely be valued using the guidelines above or at a slight discount. However, if your business strategically fits into the buyer’s other business interests, then they may well be willing to pay a premium – maybe your customers are a perfect fit for products they already sell, or maybe your business is occupying a building or location that would be perfect for something else the buyer is doing. A strategic buyer is always a better option, but that’s not always easy to find.
Finally – the type of revenue your business is earning can make a big difference in the valuation. Recurring revenue, especially if there’s a contractual component to it, is much more valuable than one-off revenue. As an example – consider the valuation of a home security company that’s generating $1M in revenue. As you can see below, if that revenue is from the installation of the security hardware (lots of one-time projects), the valuation would be $750,000. However, if that revenue is from recurring and contractual monitoring fees, the valuation would be $2M…! The profitability of monitoring is higher than installation… and it’s a much more secure, dependable revenue stream going forward.
What about your business?
If you were going to sell your business today, what do you think it would be worth? Would you be happy with that amount? If not, would you be willing to do something about it? (If so – we’d love to talk to you, that’s what the Value Builder assessment is all about…). If you’re like most business owners, you’ve been far too busy to think about any of these things – but maybe it’s time to change that up?
What do you think? We’d love to hear your thoughts – share them in the comments below.
Shawn Kinkade Kansas City Business Coach