At some point, every entrepreneur wants to know the answer to the question, “What is my business worth?”
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.
Common Measures
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?
Improve the Value
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 “What is my business 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?
Dan Weiss, founder and President of Counterpart CFO, leads a team of flexible, part-time CFOs specializing in nonprofits. To read more from Dan, follow him on LinkedIn or subscribe to his blog at www.counterpartCFO.com.