What is my business worth? It’s a question I’ve asked myself hundreds of times over my 40-year long ownership career. And valuing your business, as an exercise, is a great thing to do from time to time — it gets you thinking and dreaming, which is not a bad thing. But it wasn’t until I started buying, expanding, and selling my own businesses that I really got a feel for what valuing a business means. And now, after completing more than 100 buy/sells for myself and others, my understanding of value has become very clear.
When you start to value a business, whether you’re doing it because you’re selling or buying, there are three essential facts you need to bear in mind.
- The best time to sell a business is when you don’t have to, because that’s when it has the greatest value.
- If you don’t pick your own time to exit a business, regardless of why you’re doing it, something or someone else will, and that’s a value killer.
- Beauty is in the eye of the beholder — that is, the buyer — and the buyer’s banker.
These three issues have an overriding effect on your business’s value, and if you don’t understand their power it can be terribly costly.
In addition to these, however, there are a number of other important realities you must take into consideration when you begin to value a business:
1. There are only two ways to sell, or value, a business — an asset sale or a share purchase — and the more you know about these alternatives the better you will understand the business’s market value.
An asset sale takes place when one party sells and the other party buys the assets of the business, free and clear of liens, so the seller is responsible for paying all income taxes, outstanding debts, etc. In other words, one business winds down and another begins. Most sales and business valuations are done this way. In a share purchase, or valuation, a buyer assumes both the assets and the obligations (liabilities) of the business. This is not a popular way to buy or value a business because there may be financial obligations that the buyer is unaware of, which can raise the cost of the purchase considerably. This method can, however, provide benefits for both the seller and the buyer and, if done skillfully, can raise the business’s net overall value.
2. There are only three things to value in any business — goodwill or blue-sky, assets, and real estate.
Goodwill is anticipated profits over a certain period of time, usually measured in years. Assets are those things, such as equipment, that can be valued at replacement cost, book value, or some combination, which is usually decided on during goodwill negotiations. Real estate is the value an appraiser puts on the land and buildings. And these are something every bank looks at.
3. Accurate financial statements are a must for everyone concerned, including any bank considering lending money to a buyer.
But your financials are not the only indicator of your business’s value. There may, for example, be more (or less) demand for your products in the future, and this will weigh on the business’s value. Similarly, if you are a big part of the business’s success, with you gone it may be worth less.
4. Supply vs. demand may have a significant impact on a business’s valuation.
For example, my friend Charlie Thomas owned the Houston Rockets and sold them in the mid-1990s. He told potential buyers that if they brought their accountant or lawyer with them to a negotiation they would be wasting everyone’s time, because the price he was asking didn’t make any economic sense. Even so, he got what he wanted, because Houston was the only viable NBA franchise for sale at the time.
5. It’s important to learn as much as you can about potential buyers and their motives, because not all buyers are created equal.
Some may be willing to pay more than others, which affects value. For example, buying your business might give a competitor market dominance, which would certainly make it more valuable to that buyer than others. Similarly, one competitor might pay more just so you won’t sell your business to someone else. In other words, you can increase your business’s value by studying the value “landscape” just as you studied the marketplace, and identify your best buyer — the one who will pay the most — even if he or she doesn’t realize it yet!
Whenever you’re valuing a company — whether as an exercise or because you’re thinking of either selling or buying, it’s a serious business. And, if you’re new to this area, you will need help. The first steps are finding a business lawyer who knows the rules of the road and is willing to explain them to you, getting an accountant who can tell you about your tax consequences, and talking to other owners who have done what you are trying to do.