So, you’re considering selling your business. Whether it’s to pursue new opportunities or to get out while you can, you need to start thinking about your business from a valuation standpoint. Even if you don’t intend to sell your business in the near future, building a business to be saleable is a sound strategy. So what is your business worth?
When it’s time to leave
How do you know when it’s time to leave? If you’re experiencing these signs, you should strongly consider creating an exit strategy for your business:
Sick and tired… Literally. Entrepreneurs by nature are constantly looking for new opportunities. As a result, business owners often feel tired, fatigued, and overwhelmed by the business. Imagine constantly building your business for 25 years… it never ends, and it gets exhausting! The natural reaction is to look elsewhere, but before you start searching for the next big thing, you have to take care of your current business first. After all, it is your creation.
Decline in company revenues. A decline in revenues is never a good sign for a company. Let’s say that you’ve been trying new methods for years now, but revenues continue to decrease. Even zero growth is a red flag that you should take action.
The market for your business is declining. I used to work with someone that owned a small business before the attack on the twin towers. He flew in nurses internationally to work in his medical business, which provided him steady cash flow and a healthy bottom-line. The demand was also constant… until the terrorist attacks on 9/11. From that moment, it was more difficult to operate a business that relied upon flying in workers from other countries. The delay of bringing in nurses wreaked havoc on his business. Because of this difficulty, he decided to create an exit strategy.
Sometimes, it does get ugly. Facebook is a great example. If you’ve ever seen “The Social Network,” you’ll probably recognize this story. Mark Zuckerberg and former business partner/investor Eduardo Saverin started Facebook together, but when Saverin displayed breach of fiduciary duties, Zuckerberg diluted Saverin’s stake in Facebook. This ended with Zuckerberg’s majority ownership and Saverin’s minimal-to-nothing ownership.
How would this relate to your business relationships? When starting a business, you want to choose a partner that will be able to carry out responsibilities completely. You also should flesh out your contracts, terms, and exit strategy.
“Life is like a box of chocolates; you never know what you’re gonna get.” Things happen in life, like getting married, divorced, sick, and busy. What are your priorities as a person – what do you value most? Is a business more important than your family, or vice versa?
Assessing valuation methods
This method, as the name indicates, calculates total asset value minus total liabilities. This method is criticized, however, for its ambiguity in valuing assets. The assets may not have been recorded on the balance sheet, or may be unique or custom products that are difficult to value.
The method is best used when focusing on real estate or other similar investments.
EBITDA Valuation Multiple
This is the most popular method, and usually references the market in relation to your business. Businesses typically sell for 3X-5X EBITDA, but this can vary widely depending upon the type of business and the buyer. The ratios are calculated by taking the market value of a business, and dividing it by EBITDA.
- Business taxes
- Effect of capital structure used to finance business operations
- Cost recovery of the investment in fixed business assets
Who should you give the valuation to?
- Potential Buyers. Calculating a business valuation before selling your company is crucial if you want to negotiate prices. Let’s be honest – they’re most likely not going to buy it from you unless it’s a good deal. You might even convince them why you chose to value your business the way you did.
- New investors. Business valuation doesn’t always happen when you want to exit your company. Ironically, you value a business when growing a business, too. When pitching to new investors such as venture capitalists or angel investors, they want to know how much the business is worth before investing in it.
Investors or buyers calculate the value business based on more than just numbers. You might be selling to a current employee, someone well-versed in the industry, or a friend. There are many reasons a business owner might sell the business – relationships, cash flow, new opportunities. Both the buyer’s and seller’s motivation will affect the price of a business, so it’s important to consider all of the angles and ensure that the method of valuation you choose accurately assesses the value of your business.
Want to know some of the things that may be hurting the value of your business? Check out our whitepaper Top Ten Destroyers of Value to see where you might be leaving money on the table.
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