Small Business Valuation

Lately I’ve been consulting with people on selling their businesses. The first challenge is facing the realities of business valuation. Entrepreneurs love their businesses and have invested plenty of sweat equity. Their “baby” — so goes their rose-colored thinking — is worth, well, a lot.

While that commitment and love made the business work, the true value of the business, for the most part, is based on hard financial facts. This can be a tough reality to digest for entrepreneurs.

Of course, there are several ways to value a business, but for many very small businesses the fancier models often don’t apply. Here’s a thumbnail approach to getting in the ball park of your business’ value:

1. Add up what you paid for any existing/remaining inventory.
2. Establish the current market value of business equipment.
3. Get an appraisal for any real estate that is part of the business.
4. Take your net profit from the past year, and multiply by two.
5. Add items 1-4 together.

This basic valuation adds up to a number that disappoints most business owners.

So here is my advice: If you are going to sell the business to someone who must finance the purchase, you are better off using a pricing technique close to the method above. The loan payments must be paid out of business cash flow, and if you’ve overpriced that revenue stream, the business ends up in the red. If you have financed the purchase yourself, (as buyers without substantial assets won’t qualify for a bank loan) you could end up with a default on your hands.

You can sell your business for more than it is financially worth when you sell to someone who has cash for the purchase. Then there is no debt service in the business’ monthly expenses to jeopardize cash flow for operations. Rather odd advice, but I’ve seen it work.

Nolo Press has a great book, the Complete Guide to Selling a Business, that I’d recommend. It has more discussion on business valuation, along with many other topics. Although it recommends, as I would, consulting with professionals to help you, Nolo is all about do-it-yourself and this is a great guide to see you through.