Business Valuation; How to Value a Business For Sale

RE: Businesses For Sale

If you are planning to buy a small business for sale, one of the most critical elements of that transaction involves placing a value on the business. How can you feel comfortable paying a particular price if you don't know if it's a good deal? While public companies have a simple formula to follow in business valuation - simply look up their price per share online or in the newspaper - the same is not true for privately held enterprises. With small businesses for sale, it is necessary to do a lot more homework before you can determine what price you should be paying to buy that small business.

Seller vs. Buyer

With businesses for sale in all sorts of sectors, there are many variables to consider and critical issues to resolve in order to arrive at a proper valuation. The seller comes up with a price, and it's up to the buyer to decide if that price truly and accurately reflects what the business is worth. No value is written in stone - there is always room for negotiation, especially if the buyer has some compelling evidence to show why he or she feels the counteroffer has merit. Calling in an expert to help place a value on a business can save you a lot of headaches, as well as provide significant ammunition in proving your view of the transaction. Business brokers buy and sell companies all day long, and many of them specialize in particular industries that reinforce their expertise. Accountants can also help value a business, as can bankers.
Business Valuation Methods

Whether you hire an expert or choose to go it alone, selecting the proper valuation method - or combination of methods - is an important step in the process. Here is a list of the more common methods, along with a brief explanation of each:

Asset valuation - When a company has a lot of physical assets, such as in manufacturing or retail sales, this is a common way to determine valuation. One takes into account the current market value of all assets (including cash on hand) and subtracts the liabilities.

Capitalization of Income - This method is best utilized for companies that have few physical assets but a lot of value in intangibles, such as one that sells services rather than products. Each variable is rated on a 0-5 scale, averaged into a single score, and then used as a multiplying factor against net income. For example, if a company's score is 2.6 and its annual net income is $250,000, the valuation would be $650,000.

Cash Flow - The amount of money a business brings in the door is adjusted for depreciation, equipment replacement, and other liabilities, and then a loan amount on the remainder is determined through the use of standard lending rules. The amount of the loan is the value of the business. For example, if a banker is willing to loan you $300,000 after performing the aforementioned calculations, then the business is effectively worth $300,000.

Market multiplier - Examine the sale price of similar businesses in the same industry, comparing their annual gross sales to the price at which the business changed hands. Average this figure over the course of many transactions, and then multiply that number times the gross sales of the business you wish to buy.

Tangible assets - This is a common method for use with companies that have a flat or negative income. The firm's value is the sum of all current assets, based up on their liquidation price.

It is well worth the effort to employ more than one method, either using them together to arrive at an average, or else as a self-check. In many cases, the seller or his advisors have used one or more of these procedures to arrive at their price. One of the first questions you may wish to ask when contemplating the purchase of a small business is, "Which valuation method did you use?" Then do your own math and see if you come up with a similar figure.

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