Considering selling your business and wondering what it’s worth to a buyer?
To estimate a selling price of your business, there is a commonly used formula that combines 3 separate elements that you can use as a general guide when selling.
1. Tangible Assets (things you can see and touch)
These consist of anything from buildings, plant and equipment, to stock, works in progress and materials.
It is traditional to ask no more than the “book” or depreciated value of these assets, and it is often an area of contention as buyers seek to exclude items that do not add value for them, or are perceived to have less than book value.
In the words of one writer, your plant, equipment and stock are worth “about what they’ll bring at a sheriff’s auction on the courthouse steps in a blizzard in the middle of winter.” In other words, sellers should be very realistic about the fire-sale value of their tangible assets.
2. Intangible Assets
These include intellectual property such as patents, trademarks, brands, trade secrets and processes, plus the most common one…. goodwill.
Goodwill is essentially the “future profit earning potential” of the business and is calculated as a multiple of past profits before tax. While it is true that “past performance is no guarantee of future performance”, anyone buying a business usually does so in the expectation of enjoying a certain future continuity in sales, cashflow and profits based on recent performance.
That expectation of future performance may be underpinned by long term customer relationships (or, better still, forward contracts for supply); brand recognition and acceptance; market advantage and performance relative to competitors; and/or expected changes in market size/demand.
There may be additional value-adding factors for a buyer such as expected synergies delivered by combining a present business with an acquired business. Having said that, astute buyers will usually downplay these advantages since they arise partly from the value the buyer brings to the situation and most buyers would loathe to pay more because of the value they can add to an acquisition.
Astute sellers, however, would do well to research any value-adding potential for their buyer and factor this into their asking price.
3. Goodwill Multiplier
While it is relatively easy to call in an outside valuer to determine the market value of most tangible assets and some of the more regular intangible assets, the area of widest interpretation and therefore widest difference of opinion lies in how much to pay for the future earning potential of a company (the goodwill)… how many multiples of its recent annual average profit to accept as a fair valuation of its goodwill?
There are as many opinions on this as there are business specialists, and a lot depends on the type of industry and if it’s a franchised business. Somewhere between 1 and 5 is most common.
At the end of the day its going to depend on how badly a buyer wants the particular business. Sellers more often than not end up being very disappointed with the Goodwill component offered by buyers.
The Bottom Line
Michael Gerber (in The E-Myth Revisited) gave some great advice when he recommended that you run your business as though you are going to franchise it, or are preparing to sell it.
Businesses that have a well-documented history of strong and/or steady growth, excellent documented systems and procedures, strong people skills, proper roles and responsibilities, strong customer relationships, effective sales systems, strong positive cashflow and steady reliable profits sell easily and for a strong price.
But, at the end of the day, your business is worth no more than what someone is prepared to pay for it.
By Lindsay King
**Compiled from various sources, including some excerpts from other articles