With the day-to-day demands of running their businesses, most owners put off getting a valuation until a sale is imminent. But some are starting to treat the act of valuing their business as an integral part of running it. Everyone likes to think they’re building something that they can sell someday, but unless you focus on it, you don’t know if you really are.
There are online valuation calculators, including BodeTree, BizEquity and uValue, an iPhone app. Still, there’s something to be said for having a real person trained at valuations come in and get to know your business before running the numbers. Business brokers routinely run valuations as part of marketing a company for sale. They tend to be more detailed than the reports from online services and they cost a fraction of what a certified appraiser at a large public accounting firm will usually charge.
But before engaging outside experts, virtual or nonvirtual, it helps to have at least a basic understanding of the valuation process. Here is what you need to know:
There are essentially three methods for calculating the value of a business. The asset approach, typically used in distressed situations for the sale of defunct businesses, determines a company’s value by adding up its tangible and intangible assets.
The market approach, probably the most common way to value a healthy business, produces a valuation based on a multiple of the company’s past earnings — usually the last 12 months of Ebitda (earnings before interest, taxes, depreciation and amortization). If you found that the last 12 months of Ebitda totaled $1 million and you chose a multiple of, say, five, you would get a valuation of $5 million.
The third approach, the income method, is forward-looking, relying on the present value of expected cash flow. More common in high-growth sectors like technology, this method tends to paint the fullest picture of a company’s potential.
Picking A Multiple
While multiples can vary widely, most have fallen since the financial crisis. Part of a valuation expert’s job is to analyze the “comps,” or the multiple of earnings at which comparable businesses have been selling, to choose the appropriate multiple for your business. You can also visit business-for-sale Web sites like BizBuySell to get an idea for yourself.
Consider Your Buyer
Another factor that figures heavily in the size of the multiple is the type of buyer you think might want to acquire your business. Strategic buyers — those with a vision for how to improve your business’s operations, possibly by combining it with the buyer’s operations — tend to pay more than financial buyers
Little Things Add Up
One of the first things prospective buyers (and valuation experts) look at is the strength of your management team. If the depth chart does not instill confidence, the multiple will suffer. In addition, you may want to revisit the mix of personal expenses — car payments, children’s college tuition bills, season tickets to sporting events and the like — that you have been running through the business. While you may be getting back 30 to 40 cents after taxes for every dollar expensed now, every dollar you deduct could take $3, $4 or $5 off the sale price, depending on the multiple.
A version of this article appeared in print on January 31, 2013, on page B4 of the New York edition with the headline: Do You Know What Your Business Is Worth? You Should.