Ready to retire? Not sure how much you should sell your business for? This is a common issue small business people run into when they’re ready to close shop.
Indeed, valuing your business is pretty complex; there are a lot of numbers, facts, figures, and variables at play, and not to mention, it is hard to take an objective, factual look at your labor of love. If you value your business too high – which many people tend to do, often because of that labor of love element – then it won’t sell, but if you value it too low, you could be missing out on huge profits.
So yes, valuation is undoubtedly a tricky business, but there are a few methods and rules of thumb that can make this process a little bit easier. Let’s review:
1. Earnings multiplier: This method is relatively straightforward. In a nutshell, the idea is to multiply your business’s annual earnings by a multiplier that is based on how long the company is expected to continue operating.
Let’s say your business has consistently made $100,000 each year, and there are no new factors that indicate any big changes in the foreseeable future. A business like this could sell up to 3-5 times its annual earnings, so you could value it anywhere from $300,000 to $500,000.
Pretty easy, sure, but also pretty arbitrary. The challenge is in figuring out the correct multiplier. Often, different industries will have different multipliers – the tech industry for example often uses multipliers far in excess of 5. Be careful and do your homework with this method.
2. Asset addition: Instead of reducing your business’s value merely to its annual earnings, sometimes the way to go is to add up all of your business’s tangible assets. These assets can be
- Tools and equipment
- Accounts receivable
- Real estate
Once you add this number up and subtract any debts you owe, you will come up with a net value of all your hard assets.
The problem with this method is that sometimes it can actually end up reducing the value of your business compared to the multiplier method. So, this option too works, but it also has shortcomings.
3. Comparables: This is similar to how you might value your house. Here you look at the value of other, comparable companies that have either a) been recently sold, or b) have, in one way or another, publicized their value.
The big flaw with this method might be obvious: there is almost always more than meets the eye. That is to say that by assuming your company is comparable to another, you could be overlooking a whole gamut of variables, and thereby making a fatal apples-to-oranges comparison. There are just too many factors to consider to ever truly know exactly what you’re looking at.
4. Expert valuation: I saved the best for last.
To find out what your company is truly worth, the best thing you can do is hire a business broker and get a professional opinion. This will cost you, yes, but this is the most foolproof way for you to avoid making a bad mistake – especially if you’re new to the game.
A complete valuation is a thorough evaluation and appraisal of your business – assets, annual earnings, debts, future potential, etc. This method also takes into consideration the buyer and their skills and/or abilities. Anything you might accidentally overlook with your own quick valuation, a professional, complete valuation will make sure to account for.
When in doubt, go the expert route.