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March 8, 2018
The 5x5x5 Growth Technique – A Small Tip for Businesses That Could Yield Big Gains
March 16, 2018
I would have to say that the question “how much is my business worth?” is one of the very first questions I field whenever I start working with new small business owner clients. Perhaps at this point in our Building a Sellable Business series, you know I’m discussing the actual sale of your business now. I’ve even discussed figuring up the amount of money you need for your personal sustainability upon selling your company. So now know the sales price you need when you make at to closing table, but how much should you actually expect to get? But, how do you determine your business worth in the current market?
Podcast Time Index for “Determining How Much is Your Business Worth”
00:31 – How much is it worth?
01:15 – Realty check
03:59 – The methodology behind Business Valuations
04:39 – Three ways to value a Business
04:42 – Replacement Cost
06:49 – Comparable Value
08:21 – Income Method
10:54 – EBITDA
13:46 – Ways to increase the value of your Business
15:04 – How is the Income of your Business?
15:43 – Is there an easier way?
16:27 – Certified Valuation Analysts
19:35 – Bench Marking Software
Sticker Shock
In 2012, my wife and I decided to sell our suburban house to move to the country and live on a farm. As we prepared to list the house, we scheduled a meeting with the realtor. This realtor friend of mine sat down with us and addressed the most important question first. She asked, “Well, how much are we going to sell the house for?”
I knew how much my house was worth, so I gave her a number. Without hesitation, the realtor looked at me and said, “Um, yeah. I don’t think so,” and she quoted me the price she believed my house was worth. Hearing her valuation was like a gunshot going off in my ear, and all I heard was ringing. She quoted $20,000 less than I paid for the house before I finished the basement and did many other home improvements!
Acknowledging the sweat equity I put into the house, she still said, “While that may be true, you will never sell it for more than this price in this current market.” And she was right.
3 Basic Ways to Value a Business
Like many business owners, I thought my house was worth more than it actually was. In an attempt to keep your blood pressure down and you falling out of a chair when you find out your business’s worth, let’s first look at the methodology behind business valuations. In just about any sales process, there are three ways to value a product:
- Replacement Cost – This number can be somewhat subjective, but if a buyer looks at your business using this methodology, he will calculate how much it would cost to replace your business. Replacement costs could include physical costs of supplies, materials, equipment, technology, software, buildings, merchandise, furniture, and fixtures. Additionally, replacement could include costs to reproduce systems, hire team members, and market to new clientele. Sometimes, the replacement cost is higher than what the purchase price could be or will be. But many buyers will use this calculation in an asset sale.
- Comparable Value – Often used in franchise sales, buyers compare sales prices of similar business to determine what they will pay for yours. While some rental costs, salary expenses, or merchandise sale prices may differ from state-to-state, most franchised shops will have similar valuations. So if a McDonald’s in the next county sold for X in May, and another McDonald’s sold for approximately X in July, a buyer will most likely offer this McDonald’s owner X in August.
- Income Method – This method is the most common one buyers use to determine business worth. At its most basic form, the buyer uses an income method of value calculation if he evaluates what the business is earning now and what the business expects to earn in the future to determine current market value. Buyers use multiple calculation nuances in this methodology, but at its core is the Earnings Before Interest, Taxes, Depreciation, or Amortization (EBITDA) number. For instance, some are willing to pay three and a half times EBITDA. Others may pay 60% of EBITDA. Another might look at future EBITDA over the next five years to determine present net value.
Are the three ways I listed above the only ways to determine how much your business is worth? No, they’re not. However, those methods can determine a basic or base price tag of your company.
Grow Your Business’s Value
If your company’s basic worth is not what you hoped it would be or what you need it to be, there are systems you can put into place or things you can do to increase the value of your business.
Go back to Article #2 to look at actual value calculations and value acceleration methods. Find your competitive advantage in Article #4. Learn how to scale your business in Article #5 and how to make it sustainable in Article #7.
And of course, increasing income is going to help drive up your business worth, too. So at this point, I ask, how is your company’s income? Is it increasing year after year, or is your revenue dropping and dipping year after year? If your income stream is not increasing, then your company’s competitive advantages, its scalability, and its sustainability will make no difference to your asking price.
Business Valuation Tools
How, then, would you figure out a rough estimate of your company’s value? Well, there are two things you can do.
- Use a benchmarking tool on the Internet. – Enter in some company data to get a rough estimate of your business worth. Don’t put too much stock in the revealed value because the tools can be extremely misleading. However, the tool can be a place to start.
- Hire an expert. – Especially if you’re getting ready to sell your business now, hire a professional to give you a formal estimate of your business worth. Specifically look for an individual with a CVA credential, which stands for Certified Valuation Analyst, to add weight and confidence to your business listing price.
As a Certified Exit Planning Advisor or someone who quarterbacks the sale of a business, I have all of my business clients complete a template assessment of their business. It isn’t a formal valuation. They can’t take it to court or give it to the buyer’s side, but it does provide them with a rough estimate of your business’s value. Not only will it provide them with a rough valuation, it will give them some basic insight into the areas of their business that may need some work to increase their value.
Financially Simple also has a complimentary, confidential business value assessment tool accessible to you, my readers. Typically, I only work with my clients using this tool, but you’re welcome to use it. Go right to this valuation tool and answer questions that are similar to questions from a formal business valuation assessment.
Now, hear me loud and clear. This is NOT a formal valuation of your business’s worth. It is just an assessment. Consult with your professional exit planners and advisors to get a formal estimate of your company’s value. But use this to get an idea of what your planners will need from you to form an accurate valuation.
How Much is My Business Worth?
In all reality, your business is worth whatever someone will pay for it. But what are buyers willing to pay you in today’s marketplace? Well, use your assessment tools. Contact your professional team members. Work to increase your business’s value because more than likely, this is your biggest asset. Make it worth millions!
Next article we will start entertaining offers for the business and trying to stack the deck in our favor by using a pitch book.
As I always say, life is hard. Life is complicated. Life can be fun. Business can be complicated. Money doesn’t have to be. Let’s just remember to keep our lives, at least, financially simple. Go out and make it a great day!
