Do you know what your business is worth? One of the most important steps in selling a business is pricing it correctly. There are several ways to determine what another party would be willing to pay for your business; a formal business valuation is one option. Alternatively, many businesses can be properly priced with a Broker Opinion of Value.
Ultimately, the right approach will depend on the size and complexity of the business, the type of business, and the intended buyers of the business (i.e. individual investor vs. synergistic buyer).
What is your business worth?
The impact of improperly pricing a business can manifest a number of ways and at different points in the transaction. For example:
– A business owner attempting to sell without the services of a high quality broker may have unrealistic expectations about the value & his/her business, set the asking price too high and soon become frustrated with the lack of viable inquiries s/he receives.
– A buyer may uncover discrepancies in the inventory value during due diligence, bringing the transaction progress to a halt [if not completely derailing it].
– A prepared buyer and seller may both become frustrated due to their inability to find a third party lender to help fund the transaction.
Visit the sections below to further enhance your understanding of business valuations
“[A business valuation is] The process of determining the economic value of a business or company. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership and divorce proceedings. Often times, owners will turn to professional business valuators for an objective estimate of the business value.”
Business valuations (and appraisals) are rendered by certified and accredited professionals, affiliated with one or more nationally-recognized associations (see our Valuation Links for a list of organizations.) They are regulated professionals disassociated with the mechanics of a transaction and charge an up-front fee for their services.
Sunbelt brokers maintain relationships with national business valuation firms, in order to provide this service to clients who need or desire it. Your dedicated Sunbelt business broker will advise you on the different types of valuation services available, the associated costs, and provide you his/her professional advice on the necessity of such reports.
What Determines Value?
While there are many areas that a business appraiser will evaluate, cash flow and risk are the two important factors.
Fundamentally, a buyer purchases a business for income. Cash flow can be expressed in many ways, typically either as Earning Before Interest, Taxes, Depreciation and Amortization (EBITDA) or Seller’s Discretionary Earnings (SDE). In small business transactions, SDE or EBITDA is the most common basis for establishing a selling price.
Bottom line, the more cash flow there is, the more a buyer will be likely to pay to get it.
All cash flow comes with a degree of risk. Risk may be present in customer concentration, reliance on vendor relationships, macro economic trends, competitive forces, key employees, legal exposures and more. A formal business valuation will include an analysis of the company’s risk and quantify that risk into a percentage known as a Discount Rate or Capitalization Rate.
What About Goodwill?
Goodwill is not a random figure – it is calculated by subtracting tangible value from total value. The residual is considered goodwill or intangible value. Business sellers often over estimate the value of goodwill, assuming that things such as technology and an established brand adds “goodwill” value that should be featured into the asking price – it doesn’t, unless those items improve cash flow.
Be sure to also read our Broker Opinion of Value summary to understand how that is different from a business valuation.
t is important to distinguish a formal business valuation from business pricing, known as a “broker’s opinion of value” (BOV).
A BOV is a broker’s opinion of what a business is worth, based upon his/her personal analysis, industry expertise, knowledge of local lending, and comparable comparisons. While it is not a formal business valuation, an experienced business broker should be able to deliver an accurate BOV and articulate a realistic Most Probable Sales Price (MPSP) range.
The BOV provides a business seller with realistic expectations on what the business will sell for, given the intended pool of potential buyers, at that given time. For some businesses, the BOV is then used to set and communicate an asking price. For large businesses, an asking price is often not advertised.
As part of the BOV, the broker may also provide insights on how different deal structuring scenarios could impact the targeted sales price, and the associated tax considerations. Ideally, the broker will function as part of your overall brokerage team which will collectively consider the implications of different deal structures.
Want to know more? Contact us to speak with an experienced business intermediary.
Value is not a singular, universal term when it comes to determining the value of a business. There are at least four common standards of ‘value’ you will hear referenced:
FAIR VALUE (SPECIAL VALUE): The price at which a property will change hands between a willing buyer and a willing seller considering the specific advantages or disadvantages each party will realize (aka synergistic buyer).
INVESTMENT VALUE (GOING CONCERN VALUE): The price at which a property will change hands between a willing buyer and a willing seller considering the investment objectives of the identified buyer (aka financial buyer).
LIQUIDATION VALUE: The price at which a property will change hands between a willing buyer and a compelled seller when the property cannot be exposed to the open market for a sufficient period of time (aka orderly or forced sale).
FAIR MARKET VALUE: The price at which a property will change hands between a willing buyer and a willing seller when both parties have reasonable knowledge of the facts and neither is compelled to act.
Due to its objectivity, and excluding bankruptcy scenarios, Fair Market Value (FMV) is commonly viewed as the most relevant standard of value when evaluating a business for acquisition purposes, although other standards of value may be included in the overall analysis.
Additional questions? Contact us to speak with an experienced business intermediary.