How Much Is Your Business Worth?

Every business owner considers this question at some point in their company’s life-cycle.

Some start thinking about it before they ever open their doors, seeking to build a business right from the start which will maximize the size of their future “liquidity event.” Others don’t think about it until it may too late - after they’ve already created a company which won’t sell for as much as they need to retire, or to start their next business. Most think about it on a very regular basis.

Valuation is a verb which means determining the worth of a company, and it is equal parts art and science. The most simplistic “rules of thumb” I have seen over the years are 3X last-year’s earnings and 1X last-year’s revenue. But a variety of factors often shoot the heck out of these two approaches and even the definitions of earnings and revenue come into question.

A formula which is often used to determine valuation is called Net Present Value of Projected Future Income Streams. That’s a mouthful, so let me break it down for you.

Income Streams means cash or other items of value flowing to the owner of the company. These include salary, bonuses, perks, travel, insurance premiums, retirement plan contributions and the million other ways that a successful business owner can extract value from their firm.

Projected means that nobody can be sure that the same level of income being generated today will occur in the future - but we may be willing to project that it will. In any event, without a strong and consistent growth rate, we (the buyers) will not project that future income streams are going to be higher than they are today. If you’re so sure that a huge increase in revenue is right around the corner, then you stay and enjoy it. Old Chinese Proverb: “potential” belongs to the buyer.

Net Present Value means that making $100,000 in the third year out is not nearly the same as making $100,000 right this minute. The time value of money “discounts” future income streams - making them less valuable than present income streams. If you expect your company to throw off $100,000 in profit in each of the next three years, I may not be willing to pay even $200,000 for the rights to those streams today. That’s the value “net” of any discounts due to delay in receiving payments.

So, the Net Present Value of Projected Future Income Streams means that the seller must do a great deal to document of the consistent ability of her company to throw off profit, and be willing to take less for it today than she would if she stuck around to pocket those earnings herself.

Factors That Increase The Value Of Your Business

1. Profitability: The more money you’re making from your business right now, the more somebody else will be willing to pay to buy it. I’m talking about real money, usually the kind taxes are paid against, not the kind that you’re somehow taking under the table or “expect to make” next year.

2. Sales Growth: Businesses which have stagnant or declining sales sell for less than those with strong, consistent growth.

3. Turn-Key Operation: The extent to which your processes - from marketing to production to bookkeeping - are codified (written down in an operations manual that anyone can follow) the more valuable your firm will be to a new owner. See The E-Myth Revisited by Michael Gerber.

4. Long-Term Lease or Included Real Estate: New buyers want to continue on as before, not pick up and move the whole operation in the next 24 months. Most buyers want to see an existing long-term lease (or owned building) in place so they’ll know where they’ll be doing business and how much the overhead will cost them going forward.

5. Seller Willing To Take Less Now and More Over Time: There are 3 ways you’ll get paid: 1) Cash today; 2) Note payments over time; 3) An Earn-Out where you earn a salary during a transitionary period and are paid for your time and the continued success of the company. The less you insist on taking as cash up-fornt, the higher the total price you can charge - and vice versa.

Factors That Decrease The Value of Your Business

1. Not a Proven Money Maker: People who buy businesses are making an investment in something that is already paying dividends. If they want to invest in something unproven they can go start their own business from scratch.

2. Company Is Tied To The Owner: The more dependent your company is on your continued presence, the lower its value to any potential buyer.

3. Declining Industry: Over the past 20 years or so, the printing industry has been a tough place to sell a business.

4. Only One Buyer Interested: If you can get a pool of prospective buyers in the hunt - even bidding for your firm - you will have much more leverage in negotiating the transaction. This is where a great business broker (in essence a real estate agent representing businesses instead of properties) can be worth much more than the fees they charge.

As this post has gotten pretty long already, I think I’m going to halt the discussion right here but am considering turning it into a longer-form audio program. If this is something you want to know more about please say so in the comments below.