Think You Know What Your Business is Worth?

Many business owners believe they know what their business is worth. Some may have a solid foundation for that belief. However, this belief is often derived from third party information on what they "heard another business sold for." They apply some multiple of revenue or earnings before interest, taxes, depreciation, and amortization (commonly referred to as EBITDA) or other benchmark derived from a transaction to their business and...VIOLA...they know what their business is worth!  In most instances this could not be further from the truth.

 

Without specific knowledge of the facts and circumstances and timing of the transaction, as well as the motivation of BOTH the buyer and seller, you will have a cloudy picture of value at best. We firmly believe that the value of any business cannot even begin to be determined until you can answer a few simple questions we all learned in our elementary school English classes: Who, What, Where, When, and Why.

Let's look at these questions briefly and see how they can potentially impact the value of a business.

 

Who – Who is the seller and who is the purchaser?  Was the seller someone that had a financial motivation to sell (divorce, personal need for cash)?  Did the purchaser have a motivation outside an investment in the business? Did they want to purchase a direct competitor and its market share? Did they have a strategic reason to purchase the business, such as excess capacity or to gain a foothold in a new geographic market? Were they simply looking to purchase a job?

 

What – What actually was sold?  Was it a sale of the company's stock or was it a sale of its assets?  If it was a sale of the stock, was the entire ownership interest sold or was it a minority interest in the business? Is there debt on the books that would reduce the price an investor would pay for the stock? If it was a sale of assets, which assets were sold and which were not. Were any liabilities assumed by the new owner and, if so, which ones?

 

Where – Where a business is located and the market served can impact its value. An unfortunate fact of our great country is that certain geographic locations are simply more economically depressed than others. What may be a good price for a business in one part of the county may not be good in another, all other things being equal.

 

When – When did the transaction take place? Was the economic environment different when the transaction took place? Did the transaction take place in anticipation of an economic event that has now happened? Could any information gleaned from the transaction be stale due to the passage of time or changed circumstances?

 

Why – This one is of particular importance to know. We already touched on a few potential why's: a need for cash, elimination of a competitor, or to gain market share. Additional reasons could be to purchase a critical piece of technology or to gain niche expertise or a complimentary product or service. The owner may have become ill and needed to sell the business quickly, resulting in a lower price. The reasons could be endless, but any reason can result in a purchase price that is greater or lower for one particular business when compared to another.

 

The answers to these five questions shed light on the many factors that impact the value of a business and need to be understood by a business owner prior to reaching any conclusion about what they believe their business is worth. Blindly using transactional information from the sale of one business and applying it to another is a dangerous practice at best.

 

A qualified, experienced business valuator can help a business owner understand what truly drives the value of their business, not only today but also in the future. They can educate the owners about the different standards of value (fair market value, investment value, and others), the approaches to value (the market approach, the asset approach, and the income approach), and what the correct methodology under each of these approaches would be, given the specific facts and circumstances of your business, the current economic environment, and the reason for the business valuation.

 

Should you have any further questions, please feel free to contact us.