What you think your business is worth and what a buyer thinks it’s worth are usually two different figures. Learn what factors can influence your business valuation so you’re better prepared when you sell your business.
Deciding on a market value
Regardless of the method you use to value your business, it comes down to finding someone who will pay what you’re asking.
Theoretically, if no one wants your business, it’s worth nothing (apart from the second-hand sale of any assets or inventory).
Past cash flow, profitability and asset values are helpful starting points. But it’s often the hard-to-measure factors—like key business relationships, reliable suppliers, loyal customers and goodwill—that provide the most value.
To help you with this process, you’ll want to arrange a business valuation with a business broker, accountant or valuation expert with experience in your industry.
Factors that influence a business valuation
Your reasons for selling your business can affect its value.
For example, if you’re forced to sell for health reasons, you might have to accept the first offer. This can weaken your bargaining power and drive down the value.
A business that owns property, machinery, raw materials, furnishings, computer equipment or stock-in-hand has tangible assets with some resale value.
This makes the business easier to value because you can often find current market value or at least replacement value if you had to repurchase everything.
Many businesses have intangible assets with significant value, like:
- A well-respected brand
- Positive customer word of mouth
- The potential for growth in your industry
These intangibles can be harder to value.
If your business owns the rights to patents, copyrights or well-established trademarks, these might add value to the purchase price of a company.
For example, if you’re selling a patented invention, you might be able to value your business higher than a similar business selling an unprotected product.
Length of time
The longer your business has operated, the more likely it has a proven track record and cash flow—and possibly loyal customers who provide repeat business.
If you’ve only been operating for a short time, buyers might be skeptical about why you’re selling so soon.
A business that holds a license or distributorship rights for a product or service could be worth more than a business that does not.
If your key employees will stay after the sale, your business might be worth more. And any written agreements or incentives to retain key employees might add value.
Business valuation techniques
Remember, the actual value of a business is always what someone is willing to pay for it.
To arrive at this figure, buyers use various valuation methods, often to give a sense of reassurance that they aren’t paying too much. These are the main methods:
Add up the assets of a business, subtract the liabilities and you have an asset valuation. Nice and simple.
So, if your business has $500,000 in machinery and equipment and owes $50,000 on equipment finance, the asset value of your business is $450,000.
A buyer could decide to just buy the assets of a business rather than take over the company.
Here are some factors to consider with asset valuations:
- Property or other fixed assets that might have changed in value. Just because an asset is “valued” at a cost on the balance sheet doesn’t mean that’s what you should sell it for.
- Assets that you’ve added value to. Maybe you installed or improved it. These assets might be worth more than just book value.
Entry cost valuation
An entry cost valuation reflects what it would cost someone to start the business from scratch. This is always an option for buyers.
To make an entry cost valuation, calculate the cost of:
- Purchasing or financing assets and developing the products or services.
- Recruiting and training employees.
- Building a customer base and generating repeat business.
- Knowledge of networks, suppliers, competitors and processes.
Industry rules of thumb
In some industry sectors, buying and selling businesses is common.
This has led to industry-wide rules of thumb considered when valuing a business. These rules of thumb depend on factors besides profit. For example:
- Turnover for a computer maintenance business or monthly recurring revenue for a subscription business.
- Number of customers for a mobile phone airtime provider.
- Number of outlets for a real estate agency business.
- Net profit multiplied by an industry-standard number.
Buyers will work out what the business is worth to them, especially if they can merge your customer base with their existing business.
How you value your business comes down to what kind of business it is, how many employees you have and your ratio of asset to debt.
It’s important to get professional advice when valuing your business. A broker or accountant will know which method suits your business best and will be able to pinpoint any liabilities that might affect the business valuation.