Determining The Value Of A Small Business – When you want to sell your California small business, the first step is to calculate the business value. You don’t have to be a business appraiser or accountant to do this, but there are some important concepts to understand so you’re happy with the process and results.
The important thing is to have a strategy. Selling a small business is a complicated process, and without in-depth planning, you could be wasting money. Understanding the steps to take and getting help from the right professionals will help you avoid this loss.
Determining The Value Of A Small Business
With the help of a business broker, you can sell your small business to a strategic buyer. First, you must identify and understand the steps to selling your California small business:
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Most business owners have a number as to what their small business is worth. However, many times, small business owners make mistakes because they are not trained and it is not part of their expertise.
Also, remember that qualified and motivated buyers will have opinions. The lender will also have an opinion if the buyer needs to obtain financing from a third party, which they will confirm during the loan underwriting process.
A Broker Value Opinion, also known as a Broker Price Opinion (BPO), involves a licensed business broker performing a third-party appraisal of your small business to find the best possible selling price (MPSP).
They do this by using market data, the business’s financial statements, analyzing costs and assets, and researching and comparing your business’s revenue to the business’s sales in your industry.
What Is Valuation?
As part of a broker’s value opinion, they will use different methods to assess the value of the business. There are only three methods and they are:
For more formal situations or evaluations not used by the courts, you may need to conduct a more in-depth analysis of the business and what is going on in the business industry. This report is more detailed than the BOV.
For legal transactions and litigation, you will need a complete business report. This is called a business appraisal or full report, and is typically done in response to an IRS or court request, such as in a divorce.
In addition to the value of your business, it also details the calculations used to determine that value and the steps taken to make those calculations.
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Those conducting this appraisal need to adhere to the Appraisal Foundation’s (USPAP) Uniform Standards of Professional Appraisal Practice and the Society of Commercial Appraisers’ Standards for Business Appraisals in order for their appraisal to have any form of authority.
Now that you understand the different business valuation reports, let’s look at the best ways to calculate the value of your business. Your business broker will handle the entire process, but to start the process they will need the following documents:
Appraisers ask questions of business owners because they have knowledge of important parts of the business value.
The first part of calculating the value of a business is determining the cash flow or net profit generated by the business over the past 3 or 4 years. Your business broker will perform this step for you as it must be accurate or the business valuation will be wrong.
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After determining the cash flow or net income of the business, the business broker will use it to calculate the all-important Seller Discretionary Earnings (SDE) or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
After determining SDE or EBITDA, the business broker will perform at least a calculation using the previously described method, the revenue method, the market method, or the asset method, in order to provide a guide to the value of the business. Applying only one or two methods is not correct as this may also distort the final value of the small business.
The business broker determines the final business value after at least three rounds of calculations. This includes assigning a weight to each calculation, as a business broker may consider one valuation method to be more relevant than another.
For example, I think one of the more important valuation methods is the market method. This approach looks at products that other businesses in the same industry have sold before. That is, if the business is a manufacturing business, it makes sense to see what other manufacturing businesses have been selling over the years and generating roughly the same total revenue and SDE or EBITDA.
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Typically, business brokers are required to purchase this privately held information database because it is not public.
In addition to the market approach, there are six different ways to calculate business value. There are other methods, but be careful which ones you use, as the wrong valuation method can distort or provide an incorrect final business value. Additionally, each method has its advantages depending on the type of business you have, or as discussed below, some of these methods may only be used in certain situations.
This business value calculator involves taking a company’s shares and using them to determine the business value. To calculate it, you multiply the number of shares you own in the market by their value.
For example, if you have 100 shares outstanding and each share is valued at $1, your company would be worth $100 using this method.
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This method compares future earnings to cash flows to determine a company’s value based on profits. It also takes into account interest rates and future investments that are consistent with the company’s current model.
The discounted cash flow (DCF) method is the same as the earnings multiple. Still, it takes inflation into account and projects a business’s future earnings to show its current value. Inflation affects a company’s value, so this is a more specific picture of a company’s future value.
For businesses with large revenue streams in the market, this may be one way to discover the value of the business. It is typically used only by companies with larger total revenues (such as more than $50 million per year) or publicly traded companies. Businesses don’t typically use it in the lower middle market or on the high street.
This method is calculated by multiplying revenue over a certain period (one year, six months) by various market factors. After these calculations, you will get a value based on your revenue (i.e. 5x revenue or 0.5x revenue).
How To Value A Small Business? Best Methods To Determine Their Value
A company’s book value is one of the more direct ways to find business value. You can find it by subtracting your total liabilities from your company’s assets. Hopefully this method is not used to calculate the value of your business as this valuation method does not take into account the goodwill your business should generate.
This is one of the most brutal ways to value a business, but again, it’s not a valuation method you want to use in your business valuation. Businesses often use this method when they are closing or closing. The business closes when all of its assets have been valued and liquidated.
Before you begin a business valuation, keep in mind that over time, this value will no longer be accepted because the total business income and/or expenses will change. Organizing your financial statements, understanding your profitability, and consulting with California Certified Business Broker Andrew Rogerson can all add value.
As you can see, the process of valuing and selling a small business is complex. The best solution is to hire a business broker to help make the transition as smooth as possible. They will also help you successfully sell and exit your small business so you can leave your company privately, without any drama or complications, and most importantly, move on to the next stage of your life.
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Andrew Rogerson is a business expert with over 35 years of experience, a 5-time successful business owner, Certified Business Broker (CBB), Certified Business Intermediary (CBI), Certified Mergers & Acquisitions Professional (CM&AP), Master Mergers & Acquisitions Intermediary (M&AMI), Certified Machinery and Equipment Evaluator (CMEA), and author of 4 books. Andrew speaks by request. Andrew helps business owners plan and execute the purchase or sale of a business and advises business owners on how to make their business stronger to add value.
Buying or selling a business is a complex process—and you shouldn’t do it alone. You need an experienced business broker to guide you through the process.
We make buying and selling your business simple and straightforward. We are qualified to handle the most complex issues on behalf of our clients, ensuring you leave satisfied. Business valuation, also known as company valuation, is the process of determining the economic value of a business. During the appraisal process, all areas of the business are analyzed to determine its value and the value of its divisions or units.
Company valuation can be used to determine the fair value of a business
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