The million dollar question.
The one we answer every day.
This is the million dollar question, isn’t it? You worked really hard to create a business and you probably still work really hard in that business. You may be thinking of selling or you may want to know the value of your company for a lot of different reasons. Is it time to issue stock options? Do you need to buy out partners who helped get you off the ground? Is someone interested in becoming a partner? Maybe you are looking for a loan or maybe you just can’t sleep at night not knowing What is My Business Worth?
Some really good food for thought before we dive in to the deep: this is a business, not a job. When factoring the value of your business you need to remove the you from the equation, literally. This brings up a number of terms: goodwill, personal salary, personal expenses. So are you ready to be truly candid with the numbers and keep in mind, this result is not what the business is worth to you, because presumably you won’t be your own buyer/investor/lender, but what is the business worth in the market and to others.
So where do we begin? How about why are you looking at your business’s worth? Now don’t say it out loud in the open market, keep this to yourself and to your financial and valuation experts’ ears. Really, speaking openly and with emotion can hurt your negotiating power. You can’t lie about the numbers; so if you are selling because the business is failing then you will have to be honest about that. However, if you are selling because you are retiring, and you want to retire soon and you seem anxious and in a rush (like this sentence) to unload your business, then this can hurt you. And maybe you are valuing your business for non-sales related reasons; because you need to show a lender or a potential investor that your business is growing and revenues are increasing to give them the confidence to invest.
Here is the short answer to your question What is My Business Worth? This is a very straight forward and simplified formula for the value of a business. Take your yearly business sales and subtract your business expenses and your personal salary. This number will be your business profit. Now you will need a multiplier. This number will fall in the range 1-6 and is related to industry and growth prospect. Simple, right? Take the profit and multiply. Let’s do an example. If your sales are $200,000 per year and expenses are $80,000 and your personal salary is $70,000 then your profit is $50,000. Now let’s say you do some internet searching and decide 3 is an accurate multiple for your business so the value is $150,000. Are you satisfied with this number? Did you misrepresent this number by not properly accounting for goodwill, personal expenses, choosing your multiplier? If you want/need a more in depth valuation of your business, tips on how to improve value, or just a clearer picture of What Your Business is Worth please fill out the form to your right.
- Who is qualified to conduct a valuation (Do I look for accountants, tax consultants, appraisers?)
- What is needed to complete a valuation (What documents do I need to get ready?)
- Where is a valuation performed (I live in Virginia, can someone do this nationwide?)
- Cap rate
Now consider your goodwill; what you currently bring to the table with this business. You
business expenses are $600,000 each year. Of that $600,000, $100,000 is personal expenses that you’d have to pay out of pocket if the business wasn’t covering the costs. (These are discretionary spendings that the next owner may not necessarily carry on and are non-essential to running the business. The expenses are perfectly fine for tax purposes but will hurt your overall number for a sale if you overlook them so don’t go straight from your tax report when factoring the business value.) So you will add that back and show $300,000 in profit each year.
But wait, the new owner might not work in the business. She might hire a manager to run it. Let’s say she could do that, but she’d have to pay $60,000 to the person she hires. That being the case, the real net income of your business is probably around $90,000 each year before tax. ($150,000 profit less $60,000). This is what’s called the “free cash flow” from your business. It’s a very important number. We’ll come back to it in a bit.