Valuing Your Closely Held Business For Sale
In our last entry, we discussed the process of getting your business ready for sale. This week, we’re addressing the main reason you want to sell – to help finance your retirement dreams (even if that dream is starting a new business).
So, how do you monetize your business so that it can provide you with a return on your years of effort without your having to own and run it for the rest of your life?
The first thing is to know the value of your business – but don’t try this at home. Hire an experienced business valuation specialist, whose expertise may supply you with ideas for boosting the value of your business before you offer it for sale.
There are a number of ways via which your business can be valued, based on:
The most common valuation methods are based on your business’ expectations as to income. Expected returns are either discounted or capitalized as appropriate to adjust for potential investor sensibilities and any risks inherent in your particular business.
Income-based valuations either highlight future expected cash flows or historical earnings. There are numerous methodologies available under this approach:
- Seller’s Discretionary Earnings (SDE): this is the most common valuation metric used for businesses worth less than $5 million. SDE takes the business’ pre-tax net income, and adds back the owner’s compensation (plus any excessive salaries paid to other family members), interest, depreciation, amortization, discretionary expenses, and unusual non-recurring expenses to arrive at a valuation. But bear in mind that some lenders may not accept a business valuation based entirely on SDE – some of the items, such as high-level salaries to family members, they may decline to add back for their own valuation purposes.
- Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): this is similar to SDE, in that it takes pre-tax net income, and adds back interest, depreciation, and amortization expenses. Usually, some form of EBITDA or related methodology is used as one prong of an appraisal or evaluation of your business.
- Adjusted EBITDA: this approach is a deeper EBITDA dive, adjusting and standardizing your business’ EBITDA via removal of non-recurring, unusual, and one-time expenses and/or income entries. EBITDA may also be adjusted to account for additional staffing or other expenses which a new owner is likely to incur.
- Discounted Cash Flow (DCF): this approach is most often used for valuing a still-growing concern. The DCF Method projects the value of a business as anticipated future earnings (usually over a period of years), discounted to arrive at the current present worth of those projected earnings. It is one of the most commonly used valuation method when a business is preparing for sale.
- Capitalization of Earnings: this method is also widely used, especially for very small closely-held businesses with measurable track records and anticipated stable growth going forward. It projects future earnings based on past growth numbers. This approach, however, is based more on judgment calls than on more technical calculations, and is therefore potentially subject to an appraiser’s personal take.
Market-based valuations compare your business with publicly-traded companies in your industry. These methods assume that the value of your business can be determined based on the price paid by investors for shares in similar companies on the market. Tracking stock price to the financial statements (earnings, cash flows, and other considerations) of these companies can assist in determining appropriate ratios to value your business.
However, there are so many company-specific factors (e.g., management, market share, etc.) involved in appropriate pricing for any individual concern that a market valuation is often used as a check on an valuation based on income or assets.
An asset-based approach to valuation can provide a bottom-line – no business, after all, can be worth less than the value of its assets minus its liabilities. Some asset-based approaches to valuation are:
- Net Asset Value Method: this is a simple approach, which assumes that the values of the assets as stated on your balance sheet represent those assets’ fair market value, and takes into account intangible assets such as transferrable goodwill.
- Adjusted Net Book Value Method: this involves adjusting the asset values to more accurately reflect their fair market value. This approach assumes there is no expectation of intangible values, and that there is no transferrable goodwill.
Often a business valuation specialist will use two, and sometimes all three of the approaches above to determine the value of your business. The various methods can verify one another, providing confidence. Or they can show you opportunities to tweak your business into an even more attractive acquisition.
Again, this is something to discuss with experts – if you are even considering a potential sale of your business, please reach out to our Transaction Advisors for guidance – we can help you through every stage of the process.
Please click here to email us directly – we are here to help you.
Until next time –