By Ed Rappuhn – SCORE Nashville
”I have a successful small business and am told I should consider exit planning. Where do I start?”
The value of exit planning cannot be overrated. Earning a nice income operating your business is great, but it’s possible the greatest benefits will come at the time of sale. This is such a big topic; it’s worth two articles. Today we’ll look at the value of your business. In two weeks, we’ll look at potential markets for your business.
Many mistakenly believe the equity on your balance sheet represents the value of the business. In simple terms, balance sheet equity is your assets (what you own) less your liabilities (what you owe). The value of your business has much more to do with future cash flow projections than your equity.
Usually a buyer projects how much money they can earn from a business. This is often a multiple of cash flow. A business that has an annual positive cash flow of $100,000 is worth $300,000 if the multiple is 3 or $600,000 if the multiple is 6. There is significant subjectivity in determining the multiple. If you are in an industry expected to grow such as mobile apps, the multiple would likely be higher. A declining industry such as photo finishing has a lower multiple. Your specific business’s history is also important in determining the multiple. A business with consistent growth will command a higher multiple. Generally, the multiple is determined by a combination of your industry, your specific business’s history and projections, and how much the buyer is willing to pay.
A valuation might be higher if your company owns intellectual property such as patents, copyrights and trademarks.
Your customer lists, especially long-term customers, have value if the purchaser has complementary products and services to sell. A strategic buyer will see added financial value in synergies such as these or the ability to eliminate certain overlapping functions.
Owner’s compensation has an effect on valuation if you receive income greater than what an employee would be paid to perform similar functions. In financial statements, I recommend separate line items for owner’s salaries and owner’s bonuses. The buyer might add back bonuses to reflect cash flow available to future owners.
It’s likely you and the buyer will differ on the value of your business. Independent consultants can help put a value on your business. And, while their information is useful, they are not the ones selling or buying the business. Use their opinions as guidance but remember that the true value is the number on which a reasonable seller and buyer agree.
In two weeks we will look at potential business buyers and the benefits and drawbacks of each.
Ed Rappuhn is a mentor, workshop facilitator, and the past-chair of SCORE Nashville. SCORE mentors guide entrepreneurs in starting and growing their businesses. Sign up for a free SCORE mentor, find out about our reasonably priced workshops and other services, or volunteer to become a SCORE member at www.scorenashville.org.