How to value a small business?
 

How would you value a small business if you were to put it up for sale. I know there are probably many things to consider but there must be some basic rules for evaluation.
Jerry

There are lots of ifs, buts, maybes and countless variables with every case being different not to mention it depends if you're the buyer or the seller. Value/price ultimately is the realisable value - what someone is prepared to pay for what you are selling, whether as a package or in pieces.

As a generalisation my quick and dirty START POINT to answering your question would be assets, cash and monies due less debts plus one years turnover. Then start fudging with future prospects, value of contracts and profit levels. I would usually ignore intangibles such as goodwill and company/workforce experience and knowhow for this purpose.

5 X annual revenue.

SOLD!

I'll even throw in a set of kitchen knives. Call me when you want to pick up the keys:D

how about 3-8 X yearly earnings.

and small business are the toughest to figure out because of all the owner expenses (addbacks) that typically don;t have anything to do with how the business is run.

Wow! I've got a job for you in M&A.

Sell-side only...

Yeah, more like .7-1.2x annual revenue. And the only time a buyer would be willing to base the price on revenue is if he thinks you're a crappy manager and he can do much better. :D

The reliability of the earnings stream is the key. With many small businesses, the owner is so intertwined on both the sales and expense sides that it's hard to get an accurate arm's length view. When the owner leaves, will the customers still be customers? VERY important to show that.

Depends on the type of biz, some are normally measured as a multiple of revenue, others as a multiple of net profit, etc.

And the multiples vary depending on the type of business. The cleaner, higher profit and more absentee a biz can be, the higher the multiple. Other bizs that can make a lot of money, but are more difficult to operate, get lower multiples. A liquor store, for example, which can be very profitable, has a lower multiple because it has to be open long hours, tough labor pool, danger, and the owner generally needs to be there a lot.

Thanks for all the input. My business is not for sale but my continueing back problem has got me thinking about what i might have to do if it gets any worse. All the stuff I sell is generally made to my specs by venders but I have some assembly , packaging and shipping to do which all requires a lot of standing. The last month and a half have been a bear not being able to stand for more then 20 minuets at a time, although it has been getting better.
Jerry

I bought out a small business once.
They were turning 1.6 mill annual gross. I bought the entire company for the depreciated value of the fixed assets.

Reason for the cheap sell included very high debt load and labor issues.

My point is that the revenue can have absolutely nothing to do with value if other factors are against it.

Anyone and their dog could make revenue.

Start your valuation with a Net Present Value model and use an aggressive discount rate for the cash flows.

You may also want to pursue a due diligence. Look to understand as much about the company as possable beyond the normal sales stuff:
„P A Company profile and history
„P The financial status
„P Customer references
„P Technical, Sales and Management structure and background
„P Criminal background checks, EPA Violations
„P Process capability and capacity
„P Manufacturing statistics
„P Quality initiatives and certifications
„P Technology investments
„P Security and audit controls
„P Legal and regulatory compliance, outstanding complaints or litigation
„P What Insurance Do They Have
„P Any Hold Harmless Agreements

"the" pretty much nailed it.

You look for comps in your industry and use whatever multipliers they used--revenue, operating profit, and so forth.

A discounted cash flow model works best on established, very large enterprises who can forecast a 5-10 year model and use some different terminal value methodologies (perpetuity, multipliers) then bring it back to a present value with a discount (risk) rate appropriate for the industry, cost of capital, and age of the business.

Milu's realizable value is probably the most...realistic one, imo.

And yes, I was in M&A for many years.

JH

I recently sold part of my small business to one of my employees. Mine is a service business - an engineering company - so it's a bit different. Anyway, we went through various scenarios on how to value the business. One simplistic way to at least get some sort of ballpark number is to take the total yearly profit - let's say that number is $100K - and figure out how much someone would need to invest to realize that amount of interest in 1 year in, say, a mutual fund - one would need to invest $1,000,000 @ 10% to see the $100,000 return. Would that same person be willing to 'invest' his million in your business for the same return? Probably not, since the risk would be much higher. But what if he doesn't have the million $$ in the first place?? Well, you can finance the deal for him by 'loaning' him the money (i.e. selling it over time via monthly payments) and get the price back up to a million $$ or more.

The bottom line for small businesses is you come up with several different numbers from the beancounters as a starting point - then you throw them all out and start negotiating ..... :rolleyes: