What is the value of your business, and – if you’re not planning to sell in the near future – why do you need to know?
Business advisors say there are a number of very sound reasons to have this information. To name a few:
- Planning for adequate funds for retirement
- Ensuring that you have sufficient insurance
- Helping to make a case when raising capital
- Forming the basis for a buy-sell agreement, in which the value of an owner or partner’s share is determined in the event circumstances require a future sale
- Aiding in tax strategy and wealth preservation in estate planning
- Informing strategic business decisions and exit strategy
Fair warning: Business valuation is part art and part science, and can be heavily dependent on chance and market conditions. That said, there’s no shortage of businesses willing to provide guidance, for a fee. A trusted advisor will guide you through the steps needed to arrive at a fair value. Options include an online tool, such as the one offered by BizEquity.com; hiring a valuation expert (your state’s Certified Public Accountants association can help, as can the National Association of Certified Valuation Analysts); and hiring a professional advisor with experience in small businesses.
As a starting point, consider using the formula below. Though it is only a guideline, it can get you in the neighborhood of the right number, and help you start to wrap your mind around the issues involved in a business valuation.
Owner Benefit Calculation
This is a method of calculating what the business is worth to you as the owner and would therefore be worth to the next owner. Richard Parker, CEO of Diomo Corp., which publishes the How to Buy a Good Business at a Great Price series, explains how it works:
- Pre-tax income (as on your company’s tax return), plus
- Owner’s salary and perks (e.g., medical benefits, car), plus
- Depreciation (the amount of equipment depreciation you are permitted to claim on your company’s income tax return), plus
- Interest you are paying on business loans (since the new owner would not have this expense), minus
- Capital expenditures allocation for necessary replacement equipment that the new owner would have to purchase
Do this calculation for the past three years (at minimum) and average the totals to arrive at an Owner Benefit calculation.* (Be sure to take into account extraordinary circumstances such as a big contract that’s going to expire, or a significant one-time legal bill.)
Typically, a small business will sell in a one to three times multiple of the Owner Benefit figure, Parker says. The key factor here is a business’s chances of transitioning successfully to a new owner.
If when the owner leaves, the main asset walks out the door – as in the case of sole practitioners – the risk of losing patients or clients is high, so the sale is likely to be at a multiple of one times Owner Benefit. If, on the other hand, a business has been around for many years with stable profit, it is more likely to sell in the three times multiple range.
* This is a starting point when calculating the value of your business and is not meant to be the only determining factor. You should work with your legal advisor and ensure all relevant factors are included when determining your business valuation.
This is for informational purposes only. Cory Boyas does not provide tax or legal advice. You should speak to your tax and legal advisor before making any financial decisions. This article contains additional sources of information for your reference. Cory Boyas does not endorse, warrant or approve the content, correctness or accuracy of those third party sites.