A common question business owners want answered is how much is my business worth? Eric Gall, founder and licensed broker of Edison Business Advisors, is asked this question by nearly every business owner he encounters. Often, they make outlandish claims, for example, “I have heard my business is worth two times revenue.” or “I have heard my business is worth ten times earnings.” According to Eric, to accurately estimate a business’s value requires a deep dive into a business’s financials, assets, and additional value factors. In this article, Eric discusses how a business’s value and price are calculated.
Approaches and Methods
In general, there are three approaches to valuing a business: Market Approach, Income Approach, and Asset Value Approach. Together these approaches have eight methods for valuing a business: Direct Market Data Method, Guideline Public Company Method, Merger & Acquisition Method, Capitalization of Benefits Method, Discounted Future Benefits Method, Multiple of Discretionary Earnings Method, Net Asset Accumulation Method, and Excess Earnings Method.
A combination of any number of these eight methods are used, depending upon the business’s particular situation, to estimate value. The Most Probable Selling Price (MPSP) is then calculated by weighing each of the methods used.
Valuation Tools
There are many valuation tools to assist in valuing a business. They include sold databases and valuation software. Sold databases include BVR, BizComps, PeerComps, and BBF MLS. Valuation software is offered by many providers. These tools are used to calculate the MPSP.
Adjustments to MPSP
Once the MPSP is calculated, adjustments are made based on value factors to determine the adjusted MPSP. There are fifty-four value factors that can affect the value of a business. Some of the more important value factors internal to a business include the reliance on the owner to operate the business, concentration of sales in one or a small number of customers, lack of diversification in product/service selections or geographic areas served, age and quality of assets, and inventory adjustments. Other important value factors external to a business include the present and future state of the industry, and susceptibility to changes in laws and regulations that affect a business.
Tests
The adjusted MPSP is then tested using two tests. The first test is to ensure the business will qualify for a loan as per the Small Business Administration loan guidelines. The second test is to ensure a buyer of the business can pay themself fair compensation for their time, adequately cover any debt they incur to purchase the business, and earn a strong return on investment based on the risk incurred when acquiring the business.
Pricing
Pricing is dependent upon the supply and demand of the business type, amount and type of financing available, and in some cases interest from strategic or synergistic buyers.
Conclusion
In conclusion, estimating the value of a business and determining the price of a business is not simply accepting a business owner’s desired price or using hearsay. Eric Gall has shown why a thorough valuation and pricing analysis is required. Doing so will greatly increase the chance of a business selling in a timely manner and at a fair price.
To learn more about Eric Gall, founder and licensed broker of Edison Business Advisors, click here.To learn more about valuing and pricing a business, visit Edison Business Advisors’ website.