People start a business for all kinds of different reasons. Some people start a business because they are fulfilling a lifelong passion to create a new product or service. Others see a new business as a getaway from the grit and grind of corporate America to become their own boss. There is also a group of people that look at a business as an engine to create cash flow, create a family legacy, and build substantial wealth. Whatever reason tickles your fancy to start a business, at some juncture if the business has some success most owners ponder the question about what is the value of their business if they were to sell it to another individual. Here are some smart money moves guidelines in thinking about how to value your business.
Like any piece of real estate including your home, the valuation of a business in my opinion is part objective and part subjective. At the end of the day whatever financial and emotional analysis you run through, it is only going to be worth what a willing seller will pay for the asset. However, if you are smart about how you go about valuing your business and how you could potentially be financed out of the business, you may be able to extract a maximum amount of money from the sale depending on how you structure the deal. This is when you come see oXYGen Financial.
- EBITDA- If you have watched #sharktank, you'll often hear Mr. Wonderful talk about this term EBITDA, which stands for earnings before interest, taxes, depreciation, or amortization. While this can be complicated for some business owners to understand, an easier way to discuss this type of term is to talk about net cash flow in the business. By this, I mean how much real net profit (plus owner salary) is there coming in through the business every year. If a potential buyer is going to purchase your business, they are going to wonder under this methodology how long it will take them to make back their purchase price. Depending on the business and industry, a decent range of pricing would be 4x to 8x EBITDA. Obviously, I have seen higher or lower as it will depend on the particular business.
- Multiple Of Revenue- Sometimes, you'll hear people talk about paying a 'multiple of revenue'. A specific sector you see this happen often with is the technology sector. This is why technology companies will take their venture capital or earnings and plow them back into getting more top line sales revenue because the purchase of these businesses happen due to the potential for future profit (and revenue growth) or because the business has sustainable sticky recurring revenue. In the financial services world, you could get 2x to 3x on recurring revenue for a sale price, whereas in the technology world it could be 8x to 12x on revenue should the business sell down the road. Either way, multiple of revenue is another type of calculation.
- Discounted Cash Flow- This methodology was probably made most famous by Warren Buffett because this is the common method he uses to establish the value of businesses and often why you don't see him buy technology businesses that have no cash flow. He looks at how much cash the business generates each year, projects it into the future and then calculates the worth of that cash flow stream "discounted" using the long-term Treasury bill interest rate. They don't call him the 'Oracle' for nothing.
- Book Value- If you own a business that has lots of equipment or hard assets, you could determine the value of the business by what it actually owns. This may include real estate if it is in the deal as well. Simply put, what you are looking at in this type of valuation is to get to the equity by taking all of the assets and subtracting all of the liabilities. What wouldn't be included in this type of calculation is the 'goodwill' of the business which could include patents, brand name, etc.
There are certainly other methodologies that one can use when valuing a business and you should talk to a certified business appraiser or a qualified CPA if you want to gain a high degree of accuracy. A quick and dirty business valuation could cost $3,000 to $5,000 while an in depth analysis could be $20,000 or more. If you use these smart money moves guidelines, you can get an idea of what your business is worth.
Written by: Ted Jenkin
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