There comes a time in every business owner’s life when it’s time to transfer the business to a new owner. The owner could be ready for retirement or just ready for a new challenge.
When that realization hits, the “thought balloon” that most likely forms above the owner’s head reads: “How much can I get for my business?”
The easy answer is that a business is worth what a willing buyer will pay and what a willing seller will take. It’s rarely that simple, but it doesn’t have to be overly complex either.
Many factors play into the value of a business, but it usually comes down to three: The nature of the business, its revenue and the financial benefits the owner receives.
Buyers are more sophisticated than ever and information on valuation is widely available to professionals.
There are two ways to get a good estimate of a business’s value. The first is an independent third-party evaluation. There is a cost for this service and it involves the collection of a lot of data about the company, including its assets and revenue streams.
That data is fed through a computer program and a very detailed report is generated. This type of valuation is needed when the business is unusual so little data on comparable business sales is available. And, it’s useful because it will a support a loan application or reinforce the value of the company to the potential buyer.
There are two downsides to the independent valuation. First is the expense -- probably in the range of $1,800 -- and the second is it’s perishable. It’s a snapshot in time. As the revenue, cash flow, assets and other factors change, so will the value of the business.
A far more common valuation method is a broker’s opinion letter. The business broker uses a database of business sales, similar to those used by a broker who specializes in residential real estate sales. But instead of looking at a neighborhood and calculating square feet, then adding or subtracting for a pool other amenities, or the lack of them, a business broker looks at sales of comparable businesses with similar sales and owner benefits.
Unlike in residential sales, location is not an issue in business valuations. If a sub shop in a high-income area with lots of traffic, and one in a lower income area with little traffic, are both producing the same revenue and owner benefits, their values are identical.
Here’s a brief example of how I arrive at an opinion based on comparable sales:
Imagine that the owner of a sub shop with $250,000 in sales and owner benefits of $60,000 wants to know the likely value in today’s market.
I’d first search the database for sub shops, with revenues between $200,000 and $275,000. That search returned 30 sales. Since there were many comparables, I narrowed the search to those with very similar sales and owner benefits.
The average sub shop in this category sold for 33.7 percent of its revenue, and 1.58 times the owner benefits, which were $56,222.
(Owner benefits are more than profits and include such items as health insurance premiums, car payments and cell phones. Therefore, it requires a separate calculation. )
This search also revealed that the average sub shop in this category paid rent equal to 10 percent of the revenue and was on the market for 161 days. Of the 30 sales, 17 sold for the asking price, which is probably a good indication that the owners had professional help in determining the value.
In the end, the business is still worth what a willing seller will take and what a willing buyer will pay. But pricing the business right -- just as in residential real estate -- is key to generating interest. Buyers shy away from even looking at businesses that are overpriced.
Jon Hunt is a business broker and holds series 60 and 65 investment licenses and has completed all course work required for Certified Financial Planners.
jonhhunt@bellsouth.net
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