If you own a small business, you probably know better than anyone how much time and money you have invested in building it. But all that sweat and financial equity does not necessarily reflect what your business is actually worth. It could be worth much more than what you’ve invested. It could be worth less.
The only way to know for sure is to sell it. After all, the true value of your business is exactly what a buyer is willing to pay for it. And that dollar amount hinges on all sorts of factors both inside and outside of your control, from the strength of the current economy, to the geographic market in which you operate, to the dynamics of the industry you serve. The good news is, there are several ways to get an objective ballpark estimate.
- Compare your business to others on the market. When sellers are trying to determine the asking price for their house, they often look to see what similarly-sized homes in their neighborhood are selling for. The same idea works when you are selling a business. A variety of resources—from eBay and Craigslist to professional business brokers—can provide helpful insights on the asking and selling prices of businesses in your industry and area. Of course, no two businesses are alike. However, resources like these provide a starting point for comparing your business’ products, services and financial results with those of other companies, and can help you gauge your business’ present value.
- Use business valuation calculators. A quick online search can lead you to a variety of specialty calculators and other tools you can use to develop a rough estimate of your business’ value. Commerce Bank, for example, has a free business valuation calculator available in its online Small Business Resource Center at commercebank.com/smallbusiness/business-resource-center/calculators. Calculators like this ask for simple information about your business: your assets, liabilities, net profit and goodwill, for example, and often include instructions on how to compute them. After plugging in your numbers, you’ll get an estimate of what your business could be worth to a prospective buyer.
- Apply a multiplier. Want to fine-tune your estimate even more? Consider calculating your business’ value using a multiplier. Think of a multiplier as a measurement of risk: the higher the multiplier, the less risk your business presents to buyers and the more they will likely be willing to pay. With this approach, you multiply a specific financial metric, such as revenue or cash flow, by a certain multiplier to calculate business value. The trick is to identify the appropriate multiplier for your market and type of business. A number of references are available to help you choose the multiplier for your specific location and industry. According to BizBuySell, an online listing of businesses for sale, the national average sales price for a small business is 0.6 times its revenue. In other words, an “average” small business with $500,000 in annual revenues would sell for about $300,000 using this multiplier. Or perhaps you would like to value your business based on cash flow—your annual earnings before interest, taxes, depreciation and amortization (EBITDA), including your income and benefits. In that case, BizBuySell says to expect an average multiplier of 2.4. Using this valuation method, a business would need cash flow of approximately $125,000 to yield a $300,000 sale price.
- Get a formal appraisal. There is, of course, no such thing as an “average” business. Your equipment may be older or newer than average, or demand for your products and services may be trending upward or downward. Still, it may not be a bad idea to talk to a professional business broker or appraiser that specializes in your industry. Not only do these professionals bring an understanding of current market dynamics and industry multipliers to the table, they also offer objectivity and insights that lead to a more accurate evaluation of what your business is worth—and what you might do to increase its value before a sale.
Even if you have no current interest in selling your business, it’s a good idea to monitor its current value. This is especially true if you expect it to fund all or part of your retirement someday. It can also come in handy if you want to sell a portion of your ownership to family members or employees. The more you know, the better you can plan your future. iBi
Jonathan Williams is a Senior Vice President for Commerce Bank’s Commercial Banking Division.