Want to Buy or Sell a Small Business?What is a Small Business Value and How do you Determine It?
What's a small business worth to you?
If you are considering the option of buying or selling a small business there are a number of considerations you need to take into account. An important consideration is how to determine the value of a business.
Although many businesses for sale have an asking price there is very little consistency across the industry in terms of the relationship between asking price and value. Even if there was a consistent pricing metric it wouldn't matter because what's important is what is the business worth to a particular person...you!
In this article we'll talk about what makes a business valuable and how you might look at those value elements. You might also want to review "What do you buy when you buy a business?"
There is an entire science behind business valuation, price of the business, goodwill value, intangible value and all the other arcane and often confusing academic exercises.The important factor is figuring out what the business is worth to you or, if you are selling the business, what it might be worth to someone else.
There are a number of pricing models used for small businesses. The simplest and most often used (well, most often if you ignore the prices that are made up out of thin air) method is to create a multiplier chart for each area of the business you feel is important. Typical categories can be seen in the section below. Rate each item on a scale of 0-4, average your results and that becomes the multiple to apply to the business earnings.
Example: XYZ, Inc has SDE of $90,000 per year. You rate the catergories above with scores of 4,2,1,3. Take the average of 2.5, multiply the SDE of $90,000 and you have a selling price of $235,000. Simple, easy and reasonably effective.
Value Multiples Increase as Earnings Increase
Small Business Value Can Be Measured
Many characteristics of a business effect it's value. The principal behind pricing of virtually everything is "lower risk = higher relative value". Here are a few risk elements that could be considered important::
- Consistency and predictability of profits. Operating profits are what you need to pay yourself and pay any debt that you might incur to buy the business. Consistent earnings make it easier and less risky to borrow money to buy the business. When looking at a specific business you need to assess what the prospects are for the business to continue earning these profits. The value of the business is based on the future earnings.
- Customer/Client Diversity - A business that has a diverse customer base is more valuable than a business that only has a single customer. If you have a customer doing 70% of the business it would be an obvious problem if for some reason that customer stopped buying your product. If your biggest customer only does 2% of your business that customer would be much easier to replace and losing that customer wouldn't be a financial catastrophe.
- What makes your business expensive to replicate? - Are there any patents, trademarks, special equipment, special location or any other factor that is difficult to replace? This is where a good reputation and brand can be very valuable.
- Business Dependence on the Owner - Are there others in positions of responsibility that will be with the business after the seller retires? Having good managers makes the business more valuable. In the book Built to Sell author John Warrilow talks about what features make a business valuable. Before buying a business understanding how you will ultimately sell the business is important.