How to Value a Business for Sale
Gather information about the business., Estimate the cash flow of the business.
Step-by-Step Guide
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Step 1: Gather information about the business.
Use the law of supply and demand to inform your base valuation of the property.
Look around.
Note the sale price of any other similar businesses in the area.
This will help you get a general idea of what that type of business is worth.
You're likely to come up with a fairly wide range of prices.
Try to mentally place the business you're evaluating somewhere along that range to get an initial assessment.
Feel free to ask business owners if they have an estimate of the value of their business.
Many won't have a number ready offhand, but some might.
Examine assets.
Just as important as knowing the likely asking price of the business you're examining is knowing what assets it has.
There are two ways to assess the assets of a business:
The liquidation value method looks at the cash value of the business if all of its hard assets (things like furniture, equipment, property, and goods for sale) were to be sold off.
A thorough inventory of hard assets is required for an accurate liquidation value.
When using this method, it's important not only to get a good idea of how much each hard asset might sell for, but also how likely it is to sell quickly.
The income capitalization method supposes that the business will remain in operation after it is sold, and projects future income based on the business's past performance.
Detailed financial records are helpful in estimating income capitalization.
If you evaluate a business's assets using income capitalization, be sure to account for operating costs and other expenses. -
Step 2: Estimate the cash flow of the business.
Now that you have a better idea of the shape and size of the business you're investigating, get a more accurate picture of how money flows through it.
The most common way to do this is to apply a formula called the “seller's discretionary cash flow” (SCDF) model that provides a measure of a business's earnings.
Be sure the model works for you.
SCDF only works for businesses that are run by an owner-operator, such as most small businesses and some franchise operations.
In the case of a larger or broader business without an owner-operator (such as businesses run by a board of directors), valuation becomes considerably more complicated.
Apply SCDF.
SCDF follows a fairly simple formula.
Here are the steps:
Begin with business earnings before taxes.
Add any expenses that are unrelated to operating costs, and subtract any income that doesn't result from the operations of the business.
This typically includes things like employee benefits and personal expenses.
Add atypical and one-time-only expenses; subtract one-time-only income.
Add any expenses resulting from amortization and/or depreciation.
Add interest payments and expenses; subtract income from interest.
Add the total compensation of the owner.
If there are multiple owners, choose one.
Adjust the compensation of any other owners down to the standard for the market.
This will give you another, financially-based estimate of how much money a business is making.
Estimate the price.
Multiply your SCDF figure by a market multiple, usually between 1 and 3 for small businesses, to arrive at a market price.
Having an accountant on hand will help you get a notion of what market multiple to use.
If you have to, you can try to guess relative SDCF for similar businesses that have sold and derive a market multiple from their selling prices instead.
Detailed Guide
Use the law of supply and demand to inform your base valuation of the property.
Look around.
Note the sale price of any other similar businesses in the area.
This will help you get a general idea of what that type of business is worth.
You're likely to come up with a fairly wide range of prices.
Try to mentally place the business you're evaluating somewhere along that range to get an initial assessment.
Feel free to ask business owners if they have an estimate of the value of their business.
Many won't have a number ready offhand, but some might.
Examine assets.
Just as important as knowing the likely asking price of the business you're examining is knowing what assets it has.
There are two ways to assess the assets of a business:
The liquidation value method looks at the cash value of the business if all of its hard assets (things like furniture, equipment, property, and goods for sale) were to be sold off.
A thorough inventory of hard assets is required for an accurate liquidation value.
When using this method, it's important not only to get a good idea of how much each hard asset might sell for, but also how likely it is to sell quickly.
The income capitalization method supposes that the business will remain in operation after it is sold, and projects future income based on the business's past performance.
Detailed financial records are helpful in estimating income capitalization.
If you evaluate a business's assets using income capitalization, be sure to account for operating costs and other expenses.
Now that you have a better idea of the shape and size of the business you're investigating, get a more accurate picture of how money flows through it.
The most common way to do this is to apply a formula called the “seller's discretionary cash flow” (SCDF) model that provides a measure of a business's earnings.
Be sure the model works for you.
SCDF only works for businesses that are run by an owner-operator, such as most small businesses and some franchise operations.
In the case of a larger or broader business without an owner-operator (such as businesses run by a board of directors), valuation becomes considerably more complicated.
Apply SCDF.
SCDF follows a fairly simple formula.
Here are the steps:
Begin with business earnings before taxes.
Add any expenses that are unrelated to operating costs, and subtract any income that doesn't result from the operations of the business.
This typically includes things like employee benefits and personal expenses.
Add atypical and one-time-only expenses; subtract one-time-only income.
Add any expenses resulting from amortization and/or depreciation.
Add interest payments and expenses; subtract income from interest.
Add the total compensation of the owner.
If there are multiple owners, choose one.
Adjust the compensation of any other owners down to the standard for the market.
This will give you another, financially-based estimate of how much money a business is making.
Estimate the price.
Multiply your SCDF figure by a market multiple, usually between 1 and 3 for small businesses, to arrive at a market price.
Having an accountant on hand will help you get a notion of what market multiple to use.
If you have to, you can try to guess relative SDCF for similar businesses that have sold and derive a market multiple from their selling prices instead.
About the Author
Alexis Butler
A passionate writer with expertise in practical skills topics. Loves sharing practical knowledge.
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