What is Your Business Worth?
By Barry Steinberg, M.A.Sc., P.Eng.
Sounds like a simple question. However, the answer is not always so simple. Business Valuation is a specialty within itself. There are individuals, often accountants, who spend years studying to get the CBV designation (Chartered Business Valuator). In my opinion, the use of a CBV is a good idea, but a seller will have to be prepared to commit substantial funds to the process. If you, as a seller, are not willing to go the CBV route, your Broker/ Intermediary should have the capability to provide you with a good idea as to the value of your business. He/she should be able to examine your financial information and, with the use of standard valuation methods, give you a price range within which you will likely sell it.
There is another important factor, often overlooked, involved in determining the value of your business. Most of the time a buyer will require lender financing to purchase a business. The lender plays an important role in the valuation of the business because they will determine how much debt (including Vendor Take-back Financing) can be supported by the business based upon cash flow and asset base. Therefore, if a lender feels a buyer is paying too much for a business, they will not advance the funds. Moreover, the lender may require a third party valuation to be conducted prior to committing to loan the money.
As a seller, it is important to accept the fact that your business may not necessarily be worth what you want it to be worth, rather its value is determined in an objective and formal manner. I often hear, "but this business has a lot of potential". Buyers do not pay for potential, because future growth is a result of their own efforts. Buyers pay for a solid history of operational and financial performance. In other words, they ask themselves: If I were to buy this business, hire the current management for reasonable compensation, let them keep on doing the same things, what cash flow could I expect to get based on their history? They then pay some multiple of that expected cash flow to give them a reasonable return on their capital.
At the same time buyers often undervalue existing businesses, determined that they will never pay for "goodwill". Goodwill is not merely a flimsy term describing that which a foolish buyer gives away to the seller. Quite the contrary, it is the difference between buying an ongoing business with existing customers, supplier relationships and cash flow and starting the business from scratch, purchasing only hard assets with no customer base or existing operation. Solid valuation techniques use accepted approaches to determine the value of goodwill. It is not a number "pulled from the sky".
It is important to remember that no valuation is etched in stone, regardless of who provided it. Your business is worth what a serious, informed buyer is willing and able to pay for it on the open market. As always, it is in the best interest of both seller and buyer to find an Intermediary to guide them through the process.
In a future article we will examine why businesses with similar profit can sell for very different amounts.
Barry Steinberg, an experienced business executive, is a member of Royal LePage Commercial's Business Group. Barry specializes in business divestitures and acquisitions with an emphasis on manufacturing, wholesale distribution, and trade and professional services. Click here to contact Barry or find out more about him and how to sell or buy a business.
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