How Do You Value A Business To Buy
Dreaming of owning a small business or looking to expand your existing business by buying a competitor? Buying an existing enterprise can be easier and less risky than starting one from the ground up. But setting a value on the business can be tricky. For emotional reasons, sellers may attach a high price to companies they built. Buyers, on the other hand, need to assess the profit potential when calculating price.
how do you value a business to buy
To obtain a thorough and unbiased estimate of value for a business, you should consult a disinterested third party who has experience in business valuation. You might find a qualified expert through a bank, accounting firm or business broker. The scope and cost of the valuation will depend on the type and size of business you want to buy. Professionals may use a number of different methods to establish the fair market value of a business.
The book value approach, also called the tangible assets or balance sheet method, values the business by tallying its assets and subtracting liabilities to obtain the net worth, or owner's equity. The resulting value is considered fairly accurate if assets reflect fair market value and can be easily converted to cash. Differences in book and fair market values require calculation of "adjusted book value." This step is often required because tangible assets have been depreciated for accounting purposes so that their actual value is no longer reflected on the balance sheet.
Another common method of valuing a business is to consider its earnings potential and return on investment. The historic income of the business (either the most recent year, the average of the past few years or a weighted average of these years) is used to estimate future earnings. This figure is then divided by a capitalization rate ranging from 10 to 100 percent based on the risk factor. For example, a low-risk business that yields $500,000 in annual income with a 10 percent capitalization rate would be worth $5 million. A higher-risk business with the same income might be capitalized at 50 percent and worth only $1 million.
In many cases, the seller and potential buyer will calculate differing values for the business. The eventual sales price will depend on the perceived value of the business in each party's eyes, the degree of urgency felt by each party and the relative strength of their negotiating skills.
There are three common, acceptable business valuation methods. One may be more suitable than another, depending on the type of business being valued, including its industry, size, and circumstances of sale.
An income based valuation approach is based on projected future earnings. It is recommended for businesses that have significant potential for growth. There are two variants of this approach, capitalization of earnings and discounted cash flow (DCF).
With the capitalization of earnings method, the historical cash flow of a company is divided by its capitalization rate. A capitalization rate is expressed as a percentage and represents the rate of return on the capital including equity components and debt. This method helps to identify risks and quantify the potential return on investment. This calculation is especially useful for valuing service-oriented businesses.
An asset-based business valuation focuses on the book value of a business and deducts liabilities. It is often used in conjunction with other methods of valuation and may be required as part of the due diligence process for private companies. Struggling businesses with little to no profit may often sell at this value in an asset sale.
A market-based business valuation is one of the simpler business valuation methods, and arguably the most relevant. By comparing a business to other, similar companies that have sold recently, you can determine the market value of the business at issue. You will want to find companies with similar financials within your sector and then calculate the pricing multiples. The multiples frequently used in this approach are revenue, and cashflow (SDE or EBITDA).
For example, if an industry is experiencing a boom and popularity is growing, that would increase your multiplier. However, if the business does not offer seller financing, the multiplier may decrease.
BizBuySell maintains an inventory of hundreds of thousands of successfully sold businesses used in our valuation center options. It also helps to monitor current businesses for sale. You can narrow your search by industry and geographic location, and then narrow it further by gross income and cash flow.
Owners are often disappointed with the outcome of the various business valuation methods. The good news is that there are many ways to improve it. Remember that buyers are interested in businesses that offer the greatest potential for future profit. Documentation of several years of profit growth will add value to the company.
Seller financing is another way that owners can potentially improve the value of a business. By partially financing the sale, the owner can benefit from a higher selling price, interest income, and a wider field of potential buyers.
Hiring a professional business appraiser or business broker not only allows you to benefit from his or her expertise, but it also provides the objectivity that you may lack when it comes to making a fair assessment of the business. Many brokers are experienced at conducting a formal valuation or have connections with qualified appraisers. A qualified professional should have the designation of Accredited in Business Valuation (ABV). Accountants who have earned this certification are required to pass an exam administered by the American Institute of Certified Public Accountants (AICPA). In addition to the exam, these specialists must meet business experience and education requirements to be certified.
Valuing a business correctly is essential in a competitive market, and enlisting the help of a third-party professional will not only eliminate seller sentiment from the sales process, it will also shorten it by aligning the business value with up-to-date market conditions.
Valuing a business requires a multilayered approach, so owners will combine more than one business valuation method to gain a very accurate appraisal. Most small businesses start with an SDE and add more analysis based on sales, cash flow, and liability. All these factors combined will give you an accurate business valuation.
Three main methods are available to determine the value of a company. A valuator chooses the method or combination of methods best suited to the type of business and the information available to them.
The same issue pops up with business sales. The problem is even worse because there are far fewer sales of a business in a location than home sales. And because of this, looking at comparable sales to determine value when thinking about buying a small business is less useful.
However, suppose that this maker has a highly secret, super-efficient, patented process for making these cases. Trying to ascertain the monetary value of this technological trade secret is going to be challenging to determine.
Of course, these numbers are a snapshot of a specific moment in time. The only problem with that is that business valuation is always fluctuating. For example, what if the day after this snapshot was taken, the company was lucky enough to snag a much-coveted account.
Admittedly, this sudden influx of both new business and cash will increase the value of the company. Almost every day, something could happen that could either increase or decrease the value of the business.
To figure out this value, take the cash flow of the final year. Then, multiply it by (1+long term growth rate in decimal form) and divide it by the discount rate minus the long-term growth rate in decimal form.
The range method then would say that the value of the company would be somewhere between $95,000 and $448,622. The owner and buyer could add in other factors to adjust this range, like their opinion of the small business.
Compare your current growth rate against that of your market. Say your market grew by 15 percent last year and your business grew by 14 percent. You now have reasonable evidence suggesting to investors and buyers that they can expect similar growth levels as those predicted by industry experts.
Tip: While you can evaluate market growth and its potential impact on your company yourself, consider asking financial accounting experts for assistance or seeking a second opinion from other business owners in your network.
If you just want to value your business for your own information, keep this information in your records in case you need it for a loan or investment in the future. The next step is making your projections come true or even exceeding them to build more value in your company.
There are many reasons why you might want to know the value of your business. You might, for example, want to determine your own net worth or use the valuation to secure finance, attract investors, or sell your business. This guide provides an overview of business valuation for buying or selling a business.
You can do your own business valuation, but buyers and sellers often have different ideas about what a business is worth. It's therefore a good idea to engage a business broker or professional valuer to assess a business. They are:
Business valuations are usually based on a combination of methods. These methods are selected based on the valuation approach. There are generally considered to be 3 valuation approaches. A valuer will decide on the approach they believe will give you the best outcome.
This approach values a business based on the value of its assets minus its liabilities. It reflects the amount that would be required to create a similar business or to replace the current capacity (productivity) of the assets.
It can be difficult to justify the price you want to sell your business for. Calculating the cost of creating the business from scratch can help to validate the value. Include all the costs that would be involved in starting your business to calculate this value. Some of these are: 041b061a72