Few owners find it easy to value their own business. The worth of the equipment, the strength of the competition, the composition of the customer base and the regional economy all bear on the answer, and none of them reduces to a formula.
Buyers focus principally on cash flow: what the business earns today, what it has earned historically, and how confident they can be that those earnings will continue. In the end a company is valued on its capacity to generate consistent, transferable profit.
Normalizing earnings
The starting point is a set of recast financial statements. Reported profit is adjusted for owner compensation above or below market, personal and discretionary expenses run through the business, and nonrecurring items such as a one-time legal settlement or an unusual repair.
The result is normalized EBITDA, or seller’s discretionary earnings for many smaller companies, which represents the earnings a new owner could reasonably expect. Buyers and their lenders will test each adjustment, so every one should be documented and defensible.
Three approaches to value
A sound opinion of value weighs three approaches against one another and against practice in your industry:
- Income. The level and reliability of normalized earnings, capitalized at a multiple that reflects risk.
- Market. The prices paid for comparable businesses in recent transactions.
- Asset. The value of the equipment, vehicles, inventory and other tangible assets that transfer with the business.
Historical earnings are a central indicator, but no single multiple applies to every company. Multiples move with credit conditions and buyer demand, and the appropriate one for a given business depends on its industry, size and risk profile.
What a valuation opinion covers
We generally value a business as a going concern, on the assumption that it continues to operate after the sale. The review covers the financial statements and records, the organization and management of the company, its position in its market, and the risks within the business and in its operating environment.
A confidential valuation
A valuation establishes what the business would likely command today and identifies the factors that could improve its value before it goes to market.
What moves the number
- Earnings quality. Recurring revenue, a diversified customer base and consistent margins support a higher multiple; customer concentration, volatile results and owner dependence reduce it.
- Tangible assets. The market value of the equipment, fixtures, vehicles and inventory delivered with the business free of debt.
- Intangible assets. Goodwill, customer relationships, reputation and know-how. There is no single method for valuing them, and the appropriate approach depends on the business.
- Working capital. Buyers expect a normal level of working capital to be delivered at closing. The agreed target, or peg, directly affects the proceeds a seller receives and deserves attention early in negotiation.
A confidential valuation provides a supportable range, an assessment of what buyers are likely to scrutinize, and the steps most likely to improve value before the business goes to market.
To discuss the sale of your business, contact Twelve31 Advisors at 402-957-1231 or info@twelve31.com.
