Valuing your business accurately is essential if you don't want to risk leaving money on the table or scaring away potential buyers. Before undertaking the appraisal, put time into sprucing up your business and its financials. Effort spent at the outside will pay dividends down the road.
The value of a typical small business should be greater than the total values of its tangible assets. For a buyer, the appeal is that an ongoing business has everything necessary for successful operation — equipment, location, and inventory if applicable, not to mention experienced employees, suppliers, business processes, and a customer list — all in place, in the right amounts.
These intangible assets are frequently referred to as goodwill or going-concern value. But how do you put a price on goodwill or going-concern value? In fact, how do you determine the true market value of the hard assets used in your business? The answer is that you make a business appraiser a key player on your selling team.
Many business owners don't want to spend the time or money to have an appraisal done. However, trying to save money on the appraisal, is likely to be to your disadvantage. Guessing at the value of your business is likely to result in either a price that's unrealistically high and turns off many potential buyers, or a price that's unnecessarily low and keeps you from cashing out at full value.
Business appraisers generally are certified public accountants (CPAs) that have specialized training and experience in business appraisal techniques. As a profession, they have established a number of ways to quantify the value of key aspects of your business, and roll them up into an overall figure. As part of the process they will write up a valuation report, which explains in detail how they arrived at their final value. Having a valuation document prepared by an outside expert adds a great deal of credibility to your asking price, because the buyer will be able to see exactly how you arrived at your final figure.
Keep in mind that if you sell out to a larger company, you'll probably be dealing with MBAs who are used to seeing sophisticated financial analyses. They will be much more comfortable going through with the sale (and much more impressed with your management ability) if you have a detailed appraisal prepared.
On the other hand, remember that value is in the mind of the beholder. A professional valuation can tell you the price that an average buyer might pay for your business. However, when it comes to negotiating with an actual buyer, the appraisal is just a starting point. A particular buyer may have a strong strategic reason for acquiring your company, and may be willing to pay a premium over what the average buyer might offer. Another buyer might simply be looking for certain assets to augment his or her own business, and may not be willing to pay for your company's going-concern value at all. It's important that you and your business broker size up the particular buyer's reasons for acquiring your business before naming a price.
If you do have a professional appraisal prepared for your business, but then decide not to sell, it's a good idea to keep the appraisal document separate from the rest of your business documents.
In the event of your death, you won't necessarily want your executor to be tied down by the numbers shown in the appraisal for estate tax purposes. After all, the appraisal purports to show market value, but if no sale occurred it's hard to know whether that assessment was reasonable. Moreover, any number of things can happen in intervening years to make the appraisal obsolete.
Your estate will often come out better if your executor does a completely new appraisal for the purpose of computing estate taxes when the time comes.
Using the appraisal to set your initial price
Once your appraiser has come up with an approximate value for your business, you may decide to set the listing price slightly above the top end of the price range, to allow yourself some room to negotiate and still realize the full value of the business (or at least come close to it.) Or, you may decide that you want to sell quickly, and you'd prefer to set the listing price close to the actual appraised value or even below it.
You should think carefully about this decision and base it on your priorities, and your broker's experience and sense of the current market for businesses like yours. It's much easier to drop your asking price later than to raise it. Of course, your actual selling price will be determined during negotiations with the buyer, preferably after all the other major terms have been worked out.
In placing a price tag on your business, you need to consider:
- What factors are most important to buyers?
- How can you boost these important factors before the sale?
- How might your accountant adjust your financial statements, before showing them to potential buyers?
- What are some of the methods and formulas that are commonly used to put a price tag on a business?
- If you're only selling part of the business, how does that affect the price?
Some brokers prefer not to set a listing price at all. Instead, they'll hold a controlled auction where a number of potential buyers are contacted and given key information about your business, and bids are solicited. This can be a way to achieve a fairly quick sale at a competitive price, provided the market for your type of business is fairly strong.
Cash flow and assets are key selling points
It's important to recognize that what you love about your business are not necessarily the same things that a buyer will love. You may appreciate the intangible benefits you get from being your own boss, from your status in the community, from knowing that you provide a good product to your customers and a good working environment to your employees. Possibly you value some of your perks even more highly than the salary you take out of the business.
Buyers focus on cash flow
Buyers tend to look at a business in a much more cut-and-dried way. The essential factors that most buyers are interested in are earnings (net income after all expenses, but before capital expenditures or debt payments) and cash flow (the inflow and outflow of cash in the business.)
Buyers want to know that your business will provide a stream of dollars that's predictable, steady, and high. Some buyers prefer to look specifically at cash-flow statements, while others will focus on your income statement to examine earnings before interest and taxes (EBIT). Still others will place the most weight on earnings before interest, taxes, and depreciation (EBITD). The point is, your income stream is key. You need to prove the size and regularity of your positive cash flow, preferably with audited financials going back at least three years.
A very important aspect of your cash flow and earnings is their ability to be replicated in future years, without your presence. If your professional expertise or salesmanship is the main reason the business makes money, you will have a hard time convincing the buyer that the cash stream will continue in future years.
Buyers are most concerned about the future earnings of your business, and less concerned about the past. However, the future is difficult to predict with any degree of certainty, so most valuations are largely based on your historical financial statements. You will, however, be expected to provide projected financial statements that show how the business might be expected to perform after the sale. You may also want to emphasize your future plans: new products in development, promising new distribution methods, and other items that should contribute to income growth in the future.
Don't make your predictions about the future too rosy — they may come back to haunt you in the form of a lawsuit for fraudulent conveyance if they don't pan out. In fact, some advisers say that, absent special circumstances, you should predict only that your business will match current growth in your industry.
Assets are an important consideration
A secondary consideration for most buyers will be the verifiable assets of the business: the real estate, equipment, patents or trademarks, and even such things as inventory, customer lists, and contractual relationships you've established. These items are the buyer's "insurance" — things that can be sold or used elsewhere if the earnings stream dries up. Here's where owning your business location and equipment, rather than leasing them, can be important.
Buyers will examine your key financial ratios to see how your business compares to the industry average, to other acquisitions they may be considering, and to the criteria for purchases they have set up for themselves. A key consideration is that your business have a clean balance sheet with low debt. The buyer may have to increase the debt burden in order to make the acquisition, and won't want total debt to be too heavy for the business to support. Furthermore, a low debt load is more evidence that your business has a strong flow of earnings.
Some buyers will be interested in knowing that you have an experienced manager or team of employees in place to take over when you leave. They'll want to know that you have groomed your successors, and that the successors will stick around. Other buyers will be looking for a business to actively manage, and will want to avoid long employment contracts with existing managers.
In preparing to sell your business, your best bet may be to choose your most likely successors and prepare them to take over management of the company, but hold off on establishing or renewing any contracts with them until the buyer's identity and plans are known.