Business Valuation Blog | Understanding Buying / Selling a Company

When it comes to business valuation, small businesses can sometimes be a special case. Because of how they're operated, marketed and maintained, there are a lot of differences compared to larger companies. But exactly how are they different and what difference does it make when it comes to performing a business valuation? Knowing how to value a small business can help you determine where to focus to improve your company's operations. Here's a quick look into the process and the differences that happen when small businesses are valued.

What's different when you need to know how to value a small business?

Because of the size of a small business, many owners don't see the true potential of their company's value. They often see their business as little more than the value of the collected parts. For a restaurant owner, that may be the value of the equipment and location. But where they often sell themselves short is in terms of community goodwill and overall reputation. Let's look at an example.

Two restaurants both set up shop. One is an average cafe with boring decor, inexpensive prices and standard fare. The other takes the time to develop a western theme, a menu that is unique and friendly staff that help build the overall experience for the customer. Even if they spend about the same amount of money getting set up, the second restaurant will almost always sell for more, because they've developed a following and a reputation for innovation in the market. Their food and the experience is unique, and it's one that brings loyal customers back to the table time and again.

When these restaurants are being valued, the simple cafe may focus on the value of the equipment, while the themed restaurant takes a broader approach to value. The income of each restaurant could be projected into the future to determine the business' overall value, but would probably also reflect a wide difference between the two, probably favoring the themed restaurant which may have a higher level of profitability.

Though some larger companies are based on the public sale of similar businesses, this market-based approach may or may not be appropriate to the small business. Neither restaurant will compete with national chains, but that's not why they've been started. The themed restaurant may be able to be compared to a certain extent to the sale of a single national chain franchise, but will also have differences in terms of separate advertising and marketing demands, differences in fare demanded by the national chain for the sake of uniformity across its menu or operational differences influenced by local suppliers, profitability and similar issues. For these reasons, it's very important to be open to a range of valuation options for a small business.

Small businesses present unique challenges to the business valuation process, partially due to their structure, community goodwill and unique approach to management. If you're considering having a small business valued, you'll want to make sure you work with a certified business appraiser who has experience working with small businesses. That helps ensure they'll know how to value a small business properly. Certification ensures the methodology used in estimating the business' value will stand up to scrutiny in legal, tax agency, financial and insurance circles.

When you're running a business, wondering what your company is worth is a common question. It's one that business appraisal can answer to a high degree of accuracy, but most business owners don't have a business valuation performed except in some specific circumstances. But what are some of the common reasons for business valuations? Here's a quick list of scenarios when this type of appraisal is performed and how it benefits the business in general.

What are some common reasons for business valuations?

1. Selling a business. How do you determine the selling price of your company? A business valuation helps to determine a fair market value based on your company's specific strengths, weaknesses, assets and liabilities. When you get a business valuation performed, you'll not only gain insights into these areas, you'll be able to improve them to ask top dollar for your business.
2. Dissolving a partnership or marriage. Invariably, the individual who is keeping the company wants their loyalty rewarded by paying very little for their partner's share, while the individual who is leaving wants the best profit from their share. Because this can be such a problematic issue, there are often requirements for business valuations performed for this reason to ensure fair market value is determined and both sides are dealt with fairly.
3. Death of the owner. When a company's owner passes away and the company is willed to the family, not all family members will want to stay in the business. There can be a lot of pressure brought to bear on the executor of the will to quickly sell and settle the estate, but having a business appraisal performed allows everyone to understand what the company is worth and whether they want to take a large cut in price for a short sale or wait for the best possible price from the right buyer down the road.
4. Retirement and passing on a legacy. You've worked hard for years to build up a legacy to pass on to the next generation, and now that you've reached your golden years, you want to make the process as quick and painless as possible. Business valuations can help you determine the value of the gift you're passing on, any taxes you or your heirs will need to pay on the transfer and similar aspects, helping you plan for those costs ahead of time.
5. Seeking financial backing. When you work with a bank or other financial institution, they often require a business appraisal be performed to ensure that you're not borrowing more than your company may be worth. There are any number of areas where your accounting reports may be off, whether due to older equipment that has been fully depreciated and is still going strong or real estate assets that have lost significant value over the years. By getting a report from a certified appraiser, they know that the figures were determined using standardized methodologies that will hold up well to scrutiny.

You don't need to use any of these reasons for business valuations, however, because having an appraisal performed helps you keep in touch with where your business is going. When a certified business appraiser develops a report for your company, you'll often find there are many insights and aspects you weren't aware of that can help boost your company's overall financial health. Take advantage of this information and see where it can take your company.

When you're in business with a family member, whether it's a generational concern or a simple partnership pursued by relatives with a mutual interest, selling a family business can be an interesting proposition. There is a wider range of issues that may need to be addressed and specific steps that will need to be taken. Here's a quick look at some of the basics you'll need to know to get started.

The Basics You Need to Know About Selling a Family Business

• Find out what everyone's expectations are: What does each family member want to do with the company? If only one part of the family wants to sell, can the other part afford to purchase the business? By starting the process knowing what everyone wants out of the process, you can move forward with these prospective issues in mind and the easier it will be to come to an agreement everyone can live with.
• Plan to have a plan: Poor decision making and lack of strategic planning can quickly bleed the equity out of your family business if you don't have a plan in place prior to beginning the sale process. Start by having a meeting with all concerned parties and some trusted advisors, such as an accountant, attorney, financial planner or similar professional. Take the time to develop an overall strategy on how to proceed with the process.
• Create a decision-making process: Because there are multiple people involved in the sale,  you need to all agree on a process for making decisions. If your Uncle Joe has been the peacemaker and negotiator in the family for decades, he'd be a good option to consider in making decisions. If your sister Patty is difficult anytime someone else makes a decision that impacts her but otherwise makes great choices, make sure she's in the group that makes the decisions.
• Know what your company is worth and decide how to improve it: Getting a quality business valuation can provide you with a solid basis to determine what your company is worth. Even better, it gives you valuable insights into where your business is strong and where it's weak. This gives you an opportunity to decide whether or if you want to improve those weak points to boost the overall value.
• Make plans to aid the transition: Companies can lose significant value when they're sold to an outsider. This can make many entrepreneurs concerned about investing in the company unless there is a good transition plan in place to help make the change to the new owner. Determine which family member or members could be developed to act as a transition advisor or team to help make the overall process go more smoothly.

Selling your family business is never an easy situation, but by knowing what to do, you'll be able to make progress in the right direction. Though you'll need to look at other areas of concern, these basics should help you make a good start when selling a family business. If you need help determining your company's value, certified business valuation specialists are a good option to consider, as they are independent of any other parties in the sale and will provide an unbiased report of what the business is worth.

When you're in the process of negotiating a business sale, one tool stands out above all others whether you're the buyer or the seller: the business valuation. But why is it so important to the process and how does it protect both parties as the negotiations go forward? Here's a quick overview of what a business valuation is and what it can bring to the negotiating table.

Why is business valuation vital to negotiating a business sale?

Selling a business can seem like a fairly straightforward process. A buyer and seller connect, agree on a price and transfer ownership, right? However, it's not nearly that simple. How is that price determined? Did the seller simply look at recent sales of similar businesses in the area and use those prices? How do you know whether the asking price is fair or not? Is the buyer or seller being taken advantage of? These questions can plague those who are tied up in business sale negotiations.

Fortunately, there's an easy solution that keeps both sides happy during the negotiation process. A business valuation uses an independent third party who has had training in tested methodologies to calculate the business' overall worth. Because the appraiser is an independent party, they have no interest tied up in inflating or deflating the company's calculated value. This means that the value they calculate is much more likely to be favorably received by both parties in the negotiation process.

The appraiser is also able to use some amount of flexibility in the valuation, depending on the exact circumstances. They can create a valuation report focused on a quick sale, which may not net as much as the seller would like overall, but is often helpful when an estate needs to be settled and the heirs to the estate want a fast resolution to the process. If the seller is willing to wait for the right buyer, a higher value may be calculated to reflect that ideal circumstance.

But what about the buyer? With the independent approach of a certified business valuation specialist, the buyer knows they can have confidence that the calculated value is accurate. Because of the level of research used in the appraisal, the buyer can rest assured that there has been a solid investigation into the company's finances, the condition of the market, the industry's outlook and any special features of that business that can increase or decrease its value. 

For example, when a company has a reputation for innovative product development, the owner may inflate the asking price. But what if the owner's role in innovation is a vital part of that process? The new owner may not find as much value in the company when one of the major innovators is leaving with the sale. A business appraisal looks at these aspects and how the company will change with the sale. They can then take that into account and determine how much of an impact that will have on the overall value.

By getting a business valuation as a part of the process of negotiating a business sale, both sides realize significant benefits in the process. They can walk away from the negotiating table knowing that they've done a good job. The valuation process, when completed by a certified business appraiser, helps ensure that everyone is getting a fair deal. 

When you're preparing a business for sale, it's a difficult process. You look at your income over the past few years, how much other companies have sold for, potential interest in the company and similar issues, planning for the impact they can have on your overall expected sale price. But what if you could gain valuable insights into a wide range of strengths and weaknesses within your company, providing you with a significant opportunity to improve your company prior to putting it up for sale. This can lead to a much higher overall sale price. Here's how an appraisal can help you in this process.

How does a company appraisal help when preparing a business for sale?

There are a number of ways in which a company appraisal can be used to start developing a plan of action to ensure your company is ready before you start working through the sale process. In the initial stages, a business appraiser will look at your company's financial records. They'll be able to make adjustments to your bookkeeping entries, helping ensure that your financial statements are adjusted to reflect your company's actual income and expenses over a longer period of time. 

Another way that you'll gain benefits from your company appraisal happens when the appraiser begins to look at your company's overall assets and liabilities. Has your real estate significantly increased in value since it was purchased for your company? Is your equipment valued accurately, or do you have assets that have been completely depreciated but still retain value, such as an older but dependable work truck or table saw that was expected to fail early on but continues to function well. They may be able to recommend options to improve your late accounts in your accounts receivable or similar solutions to help improve your liabilities.

What is your company worth in today's market? Though it's easy to guess based on other somewhat similar companies in the area or market, that may not provide you with an accurate picture of your company's true worth. Market-based appraisals look at similar companies but then adjust the value based on a wide range of aspects, including the total receipts and other factors. Your company may have significantly more goodwill or a better reputation in the community, which also has significant value that is often underappreciated by owners or executives. It may have areas in which it leads the industry or innovative new products that are regularly developed, providing a strong benefit to the new owner in terms of a strong brand name that will help ensure strong growth well into the future. 

By knowing which aspects of your business are strong and which ones need to be improved, you can focus on improving the overall picture potential buyers will have of your business. Whether you've spent decades building your company or are simply preparing to sell a short-term investment, having a professional business valuation performed on it can help you vastly improve your overall profit from the sale. Make sure that you use a certified appraiser, as they will use standardized methodologies that will stand up well to scrutiny, ensuring that you have accurate information to make improvements to your company's bottom line prior to the sale.

When you run a small business, you know that you wear a lot of hats, sometimes with limited degrees of success. But when it comes to small business valuation services, you may feel a bit more in the dark than usual. What's involved in the process? What will you need to provide to your business valuation specialist to make the process move along more smoothly? Is it more than just looking at assets versus liabilities? Here's a quick look at the overall process and how to prepare beforehand to ensure a better, faster result.

Small Business Valuation Services: What to Expect in the Process

Going through a business valuation can be a daunting prospect, especially when the business is relatively small. Fortunately, it's not nearly as difficult as it may sound. To start, the appraiser will ask for some details on your company and will almost always request copies of some of your recent financial statements, such as tax returns, income statements, balance sheets and similar information. The appraiser can then take that information and study it to see where your company's patterns fall and where adjustments may need to be made to create a more accurate view of your company's average activities across the years. They may ask for additional information or ask questions about reports that fall outside of the norm. 

Once the appraiser has a good grasp of what your company's income has been, they can look at a number of different aspects that may also impact your company's performance. What condition is your industry in? Is the market thriving or failing right now? These aspects can impact how well your company will do in the future, so they have a strong impact on the appraised value of your business.

One question that often takes business owners by surprise is when they're asked for the reason for the appraisal. A company's value should be the same across the board, right? Not necessarily. When a small business is being sold due to the death of the owner, the heirs may be willing to wait for the right owner or may want to dispose of the company quickly, which will impact the selling price. In other cases, one heir may be interested in buying out the others to keep the company in business, in which case those selling will want to get as much as possible while the buyer will want to pay as little as possible to keep the legacy business in operation.

Another area of concern is the importance that your company's reputation, goodwill in the community and innovations will play in the overall value. When a company is known for delivering superior service or products, it will often sell for more than one that offers more average fare, as will a business that has become a fixture in the community. A reputation for innovation in design and services can also quickly raise a company's value much higher than may otherwise be expected.

By knowing what to expect from small business valuation services when you're planning on having your company appraised, you can be better prepared for the experience and can help ensure it moves along smoothly. However, when selecting a business valuation specialist, make sure you look for one who is certified and who has experience in your industry. This will help ensure that the process goes as quickly as possible while making sure the report generated is the most accurate it can be.

When you're looking at a business' overall financial standing, one term that is often tossed around during a business appraisal is valuation multiples. Multiples of what? How is the number calculated? What does it mean to your company's value on the market? Though it can seem like a complex concept, it actually breaks down fairly simply. Here's a quick overview of what valuation multiples are, how they're calculated and how they can impact a company's overall value.

How are valuation multiples calculated and how do they impact your bottom line?

What are they?

Much like multiplication, a valuation multiple represents a specific business value multiplied by a particular figure. That value is typically related to income in the form of discretionary earnings, gross revenue or market conditions. The figure by which it is multiplied is the valuation multiple. Depending on the company involved, this multiple can be anywhere from a small single digit to pushing three digits. 

How are they calculated?

Multiples represent a certain expected amount of income per year. If a company has a multiple of 3x, it means that a buyer is willing to pay the equivalent of three times the expected income to the seller. This means the company's income will pay back the investor over the course of three years, if it continues to perform as expected. A multiple of 5x means the company is valued at five times the projected annual income and that a buyer will see the investment returned over a five year period. However, if a company is actively growing, much higher multiples may be seen.

How do they affect your company's financial situation?

But what impact can these multiples have on your company's financial situation? A startup tech company may only have revenue of $50,000 the first year of operation and $200,000 the second year. If it's purchased at this point, where should the multiple fall? If it's expected to grow to a $20 million annual concern within five years, even paying a 10x multiple on the current $200,000 annual income would only equal a value of $2 million. In this case, a 50x multiple may be considered acceptable.

This not only applies to buying and selling a company, but also to the process of securing financing. Will the tech company, as it stands, be able to reach that level of growth? If it needs additional capital to be able to pull off the expansions that are needed, the company needs to be able to prove to the bank that the company will be able to pay back those funds in good time. An appraisal from a certified valuation specialist uses standardized methodologies to document the company's ability to repay the loan that stand up to strong scrutiny in financial circles, making it easier to secure the financing.

By having a good idea of how valuation multiples are calculated, you're in a better position to improve those numbers and pay or receive a fair price for your company, whether it's for a business loan, a company sale or a business purchase. Knowing where your business stands allows you to improve areas that are weak and push areas that are strong even further to help ensure a successful venture. By working with a certified business appraisal specialist, you're ensuring that the multiples and figures you work from are accurate and represent a solid calculation of your company's overall value.

When you're trying to figure out your company's finances, there are a wide range of formulas and techniques that are available. But which one will work for your company and how will the different options impact your bottom line? One option is looking at earnings before interest, taxes, depreciation and amortization (EBITDA). But exactly what is EBITDA? Here's a look at how this type of value is calculated, what it means to your company and how it can affect your bottom line.

What is EBITDA? How does it impact your company's finances?

So exactly how is EBITDA broken down? Let's take a look:

• Earnings: This refers to net profit, or the amount of money your company is bringing in minus expenses and overhead.
• Before: This one's as simple as it sounds - it's the earnings before everything else is taken away.
• Interest: Interest is typically the figure listed on your company's income statement. It represents the cost of interest on loans and similar financial instruments for that period.
• Taxes: Taxes are also taken from a company's income statement, making it easy to work them into the figure. This refers specifically to income taxes only.
• Depreciation: Depreciation refers to how much value an asset has lost over a particular time period. It may be determined using a depreciation table or schedule, or using an equipment valuation to determine change in value.
• Amortization: Amortization is the expense of a loan, typically in terms of the amount of the loan that has been paid over the year, representing a gain in an asset's value to the company and a lowering of debt.

In general, EBITDA is a great way to determine a company's profitability, but not necessarily its cash flow. This is because it does not actually represent cash earnings, but looks at a wide range of other factors that may come into play with a company's finances. Because it is not a generally accepted accounting principle measure, there is greater leniency with regards to what exactly is included in the statement. It was originally developed to determine a business' ability to service debt. As time rolled on, it became more common when industries had expensive assets that were used for long periods of time. Since that time, it's become a commonplace calculation in virtually every available industry, including the tech industry.

Another report that provides the same basic information is the earnings before income and taxes, or EBIT. The only difference between these two is whether the depreciation and amortization are included in the calculation. When they are excluded from the report, it doesn't mean that they're not being counted, because earnings in this situation refers instead to the company's operating profit.

What is EBITDA? Now that you have a better idea about how this income can be calculated, it's much easier to gain an understanding of how your company operates and its overall financial health. Another aspect of that understanding is the insights you can gain from a business valuation. Business valuations not only provide you with the value of your company, they also deliver information on the market, the industry, your competition and where your company is strong and where it is weak. Why not look at having one performed to see where your company can go from here?

When it comes to the value a family business may hold for different members of that family, the results are mixed at best. One person wants to know the fair market value while another wants to wait for the right buyer and a third wants to know how much they can get right now with a liquidation or salvage price. Which approach is the right one for which situation? Here are a few scenarios to consider when determining the best answer to that question.

Business Appraisal: The right value a family business needs

• A grandfather is passing on his construction company to his grandson. Both of them realize that some amount of money needs to change hands. But while granddad is trying to fund his retirement, junior is trying to break into the business for the lowest possible outlay. Finding a fair market value is an excellent way to make sure both sides get a fair shake and a great deal.
• Two brothers have run a printing company together for years, but now one wants to try something different. They both want to be fair while still ensuring that the printing company can continue to function well for years to come. How do they determine the value the brother who is leaving brings into the company to compensate him for his work and investment over the years?
• After the terrible car accident that took their father's health, the family is trying to figure out how to sell off the company that he had built over the years. One sibling stayed at home to care for him and, feeling the financial strain of caregiving, feels the company should be sold off as quickly as possible. Another sibling wants to hold onto the company as long as possible to find the right buyer to maximize profits. How should the situation be handled in a way that is acceptable to all parties? 
• A daughter has finished an exceptional education and is coming back home to help run the family business by running the marketing department. Her brother never left after high school and has been operating a forklift in the warehouse for several years. The ideas the daughter is bringing to the company may provide significant growth while the brother has steadfastly made sure everything was done while she was away. How can the parents make sure each child gets an equitable portion of the business and how is that figure determined?
• A family member has contracted a serious illness and needs to cash out their portion of the business to cover expenses while receiving treatment. Should the value be determined at a salvage value, a fair market value or based on income that is expected in years to come? How can that value be determined fairly for all family members, both leaving for health reasons and those staying to maintain the company?

By knowing what you're trying to accomplish with a business appraisal, the value a family business may bring can be made much clearer. But before you simply look in the paper or call a realtor to decide how much your family business is worth, you'll want to consult with a certified business valuation specialist. They can help you find the right method for your situation while providing you with valuable insights into your company, competition and industry.

What is Seller's Discretionary Earnings (SDE)? As the wording suggests, it's a type of earnings or income that is calculated when a business is changing hands. But how is it different than other types of income you may see in the business world and how will it impact either your company or personal taxes, especially as it can impact a company's value as you enter the sale process. Here's a quick look into exactly what SDE is and how it can affect your finances.

What is Seller's Discretionary Earnings (SDE)? A Quick Look at this Earnings Type

Let's take a look at SDE based on each side of the equation during a business sale. If you're considering buying a business, the seller's discretionary earnings provides you with the information you need to develop an accurate prediction on your return on investment as well as get a better understanding on how realistic your expectations are of the business itself. For the seller, this calculation allows you to maximize your business' overall value before you get into sale negotiations. Preparing a business for sale can often bring up a range of various expenses which may or may not have an effect on a company's overall valuation. Understanding SDE allows you to make smart decisions while preparing to sell.

But how exactly is SDE calculated? If you've been following our blog, you may have seen the explanation of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) a few posts ago. SDE is a combination of EBITDA and owner's compensation. Here's a look at what is often considered to be part of calculating owner's compensation:

• The benefit expected to be given to one owner. As a standard part of this calculation, this is an adds one owner's compensation back. This is especially important when a share of a business or partnership is being sold. When several owners actively participate in operating the business, the calculation requires that projections be calculated to determine the value of the selling owner's effort and labor in the company.
• One-time expenses that were paid. These expenses cover a wide range of single purchases, but can include things such as a website design service, purchasing a specific license, an application fee for a particular service, benefit or membership as well as any number of other one-time expenses to the company.
• Non-business-related income or expense. Did you run consulting income through an e-commerce business? Was there a little extra time you took for personal time on a business trip? Maybe you charged your business rent for the cost of your home office. If you needed to put an automobile expense through your company when it doesn't typically need a car to do business, that's another example.
• Adjusted expenses. Let's say your business has a small website but also a large warehouse. The expense of the warehouse to fill orders must be adjusted as part of the website's expenses and is worked into the business' overall earning statements.

What is Seller's Discretionary Earnings (SDE)? By having the answer to that question, you gain a much better grasp of exactly how your business' finances function and what changes you can expect as a business changes hands. Understanding this type of income calculation means you can better understand how a company is being valued based on this type of income and how it will impact your final business value figure for the sale.