Learning how to value your small business is very important if you are considering selling your business in the future. In reality, roughly 30% of all businesses actually sell. This is largely due to the wide range of values calculated for a business’s worth. However, a solution grounded in economic reality exists for valuing your business.
By taking into account your adjusted net income, multiplier, and terms of the deal, you can reach a value of your business that is accurate and will likely attract potential buyers.
1. Calculating Your Business’s Adjusted Net Income
First, you need to calculate your business’s adjusted net income. This figure is derived from all profits, salaries, and all cash-related benefits associated with running your small business. Cash-related benefits often include an owner’s use of a company car, premiums for life, health, and auto insurance paid by the company, personal expenditures, subscriptions, and any other business expenses.
Additionally, interest expense, amortization, and depreciation should be added into the adjusted net income as these items are expenses that are often not reported on profit and loss statements.
When calculating your adjusted net income, it is crucial to keep accurate and thorough records as prospective buyers will want to see any and all statements used to calculate your adjusted net income. Doing business without accurate record-keeping greatly exposes your business to tax liability with the IRS and will likely drive away potential buyers.
It is important to note that an accurate adjusted net income will be based on a lengthy history of income and expenditures. A few months of records will not suffice as a short period of time does not accurately reflect the overall condition of your business’s finances.
2. Calculating Your Business’s Multiplier
Second, you need to consider marketplace expectations by calculating the multiplier. The multiplier is a figure that is calculated by determining how much people are actually paying for small businesses. A rough value of your company is derived by computing the multiplier with your business’s cash flow (multiplier x adjusted net income).
Typically, low risk businesses with a high market demand are reflected with a strong multiplier. Often, a multiplier might be calculated at two to three times your small business’s adjusted net income if the business is particularly attractive. However, lower multipliers like a one or two multiple are commonly associated with businesses that pose a greater risk for potential buyers. Additionally, a lower multiple can be the result of a lower market demand.
Businesses with higher multipliers are often manufacturing companies, profitable distributorships, or businesses with a great deal of assets such as inventory, equipment, and trade fixtures. However, restaurants and other commonly found businesses command a lower multiplier due to the abundance of those types of businesses that are for sale at the same time. Overall, multipliers are factored by supply and demand.
3. Defining the Terms of a Sales Transaction
Finally, the terms of a transaction are vital in determining the overall value of your business upon sale. A deal’s terms are vital as the cash flow of a business must be able to support the price being paid after taking into account the multiplier. Selling a business for a higher amount of cash up front than the expected adjusted cash flow places the buyer in a precarious financial position. If this is the case for your small business, adjusted the price lower will likely be more appealing to buyers.
However, if your business’s level of adjusted net income will support a buyer to pay more for your business, you can likely command a higher sales price when selling your business. Other ways to attractively structure a deal is to delay payments for a few months, provide a low interest rate, or allow the buyer to make interest payments only for a short period of time.
Overall, valuing a small business is more of an art than an exact science. Sellers need to consider multiple factors and be willing to structure a deal that will be beneficial for both parties in order to successfully value and sell their business.