Dear M & M:
I am thinking about selling my business. What should I do to come up with a good selling price?
Many times what one thinks something is worth and what they can actually get someone to pay has extreme differences. There are several ways to look at it. The first thing I always calculate is what it would cost to start from scratch to buy all the assets to build or replicate your business (land, fixtures, equipment, inventory, supplies etc…).
This is method is commonly referred to as replacement value. There are many things like trained employees, work processes, location, reputation in the community, ready build customer base that are subjective and sometimes hard to put a numerical value on.
On the other hand employees, location and processes sometimes can be negative parts to any business and not add value. As we all know unfriendly employees, poor locations and outdated equipment can have reverse implications to any added value.
A second method is called comparison. In a comparison valuation one would have to determine value or worth to similar businesses that are in the same relevant condition in the same general geographic area. This is very hard to do as we are never comparing apples to apples as every business is unique and brings with it differentiating parts that cannot be easily replicated elsewhere.
One has to take a strong look at the income the business produces and value of the business assets in comparison to another business when using the comparison method. When using the comparison method I use of the word similar loosely. Similar doesn’t necessarily always mean comparing a restaurant to a restaurant.
Shop around what income would a furniture store produce in a same size building with equal value in inventory compared to value in equipment? I understand the skill set to run a restaurant or a furniture store is entirely different and I wouldn’t recommend to anyone to buy either business if you did not have any experience in running that particular type of business.
However, keep in mind money spent and return on investment. Making money and return on money spent is a consideration both buyers (when buying) and sellers when (pricing to sell) should consider. A third method called the valuation method takes into consideration the tangible assets of the business and adds a multiplier to give additional credit for annual profits to determine selling price.
This valuation method takes various business metrics like competition, entry barriers, loyal customer base, number of years in business, growth potential, industry standards, technology, difficulty to manage, forecasted future potential, banks willingness to loan money to the business and reputation and puts a ranking on each areas to determine a multiplication number usually from (- 5, -4, -3, -2, -1, 0, +1, +2, +3, +4, +5).
The higher number the lower the risk. For instance is the company’s earnings are falling and they lost money the last 3 years they would be assigned a lower multiplier and could have a negative impact (-3). Let’s say they had the best location town, I could see them being assigned a (+5) or a (+6). After assigning various risk numbers for each category one takes the overall average number to use as a multiplier.
Then the annual earnings after all expenses are multiplied by that number to arrive at a monetary number to add to the tangible assets to arrive at a selling price. For example my annual earnings after expenses (cost of goods sold, salaries, interest, and administrative expenses) are $50,000 and multiplier is 2 (based on my calculations of several factors as described above) my valuation of the value of annual profits would be $50,000 X 2 = $100,000.
My total asking price would be $500,000 valuation of the tangible assets and $100,000 valuation of the annual profits using the multiplier making the total asking price of $600,000. As always get professional people involved. Before you make an offer to sell make sure you consult an Attorneys to look at the sales contract , have a CPA look at your tax situation after the sale, use Real Estate Appraisers for property appraisal assistance, business advisors and other business owners are just some of the people you should make part of your team.
To ask your questions: Call the Small Business Development Center (SBDC) at Cochise College 520-515-5478 or email email@example.com or contact the Sierra Vista Economic Development Foundation (EDF) at 520-458-6948 or email firstname.lastname@example.org