The bad news is, it's not as much as you think.
The good news is, you can improve on this.
First, let's revisit the bad news. Most small businesses are dependent on the expertise and work ethic of the owner. If the owner wants to “cash out,” a potential buyer will want to evaluate what's left.
Here are some common methods of measuring business value –
Net Assets. The fair market value of the assets less the liabilities represents the business value. This is usually not advantageous to the seller because it doesn't account for the goodwill of an ongoing business.
Market Comparisons. If you're selling a restaurant, evidence of the selling prices of similar restaurants will provide points of comparison.
Multiple of Revenue. Recurring revenue streams are often valued as a multiple of revenue (e.g., eight times monthly revenue). In these situations, a buyer will often seek to integrate the revenue stream within another business. In so doing, two small and unprofitable portfolios of revenue combine to form one larger more profitable revenue stream.
Expected Future Income. This is, arguably, the best measure of value for almost any investment, including a business. The difficulty lies in the assumptions. How much future income will there be? Since income in the future is worth less than income now, at what earnings rate (i.e., interest rate) should the future income be discounted?
Now, let's revisit the good news – that you can improve the value. It will require some work, but here's what you need to do –
- Develop a GAAP-compliant financial reporting system. A buyer will demand this, and your tax returns will not suffice.
- Create a systems-dependent business environment. Your business should be able to function at near-peak performance without you present on a daily basis. Otherwise, why would someone buy your business?
- Maximize your profitability and cash flow. Ultimately, these are the most convincing evidence of the value of your business.
Many business owners are sobered by the reality of how little their business is worth to a potential buyer. This, however, should provide a poignant reminder – even motivation – of the need to maximize excess operating cash flow today to build a nest egg for the future. After all, isn't that security what you ultimately want from your business?
Would you like to enhance the value of your business by having it produce maximum results for you today? Contact Counterpart CFO for a free, no obligation consultation, and we'll identify specific ways we can help you.