What Determines the Value of a Business For Sale?
The listing price of a business is more than just a price tag; it’s a profile of the business itself, market conditions and brand potential. It’s easy to assume that the value of a business is based solely on the revenue that it is pulling in. In fact, there are plenty of contributing factors that you might not be considering.
Potential buyers will look at everything from cash flow and existing assets, to location, vendor relationships, future projections and even location. When selling your business, it’s important to look beyond the balance sheet, and a business broker will help to do just that.
Common Approaches to Business Valuations
The climate of business ownership is changing. A 2023 KPMG Survey found that 70% of family business owners are looking to accelerate succession plans. This may be due to changing tax regulations, medical needs, early retirement or a strong market. Whatever the reason for selling might be, understanding the value of a business is incredibly important to the outcome of a sale.
There are several angles from which to determine a business’s worth. The most common business valuation methods include: the income-based approach, the assets-based approach or the market-based approach.
Income-Based Approach: One of the most prevalent methods for determining the value of a business is the income-based approach, which revolves around EBITDA (earnings before interest, taxes, depreciation and amortization). This metric measures a business’s ability to generate operating earnings. It’s common to apply multipliers to EBITDA, depending on the profile and size of a company. Which type of multiplier is added will depend on a variety of factors, including the market, IP and the location of the company itself. Smaller companies will often earn a multiplier between 1 and 4, while medium-to-large companies can demand multipliers between 3 and 6.
Assets-Based Approach: Another method of valuing a business is based on its held assets. This type of valuation will consider both tangible and intangible assets. In certain cases, a company may be more valuable in pieces instead of as a whole. Each piece of equipment, machinery or inventory counts as a tangible asset. For large or small businesses that own offices or real estate, these should also be included in a valuation. Anything that can physically change hands from one owner to another counts as a tangible asset, but an established business holds value elsewhere, too.
No one can buy brand recognition. Familiarity and reputation are built up over months, years and decades of hard work. A brand is cultivated by a business owner who has put blood, sweat and tears into its development. Brand-name, intellectual property, and goodwill within the industry are also considered within the assets-based approach.
Market-Based Approach: The state of the market will have an impact on the sale price of businesses. When an industry is in decline or experiencing regulatory shifts, it’s unreasonable to expect to achieve top sales prices. Growing industries (technology, automation) will demand higher EBITDA multiples than those within declining sectors (forestry, manufacturing). One way to gauge this valuation is by looking at the sales history of similar businesses.
For those business owners who are looking to sell, there are other contributing factors to consider when determining the value of a business:
- Operational Risks: Potential buyers will review potential risks just as closely as they do the financials. In the same way that a tangible asset can improve the valuation of a business, a risk can reduce it. For example, if business operations rely heavily on the daily presence of the owner, it is seen as a risk. If a business can run smoothly without the owner being present, it’s an advantage that will increase value. If the majority of revenue is dependent on a small number of customers, it can put the health of the business in a precarious position.
- Consistency & Security: Part of what makes a business profile appealing is consistency. Having a profitable quarter is great, but that doesn’t dictate positive growth in the long-run. Being able to showcase a positive trajectory year over year gives potential buyers peace of mind. Long-standing contracts with vendors or long-term leases for office spaces or warehouses are assets to potential buyers.
- Modernized Systems: Is the business modernized? For mature businesses or those in traditionally low-tech industries, ensuring that operations are modernized will be a selling feature. Potential buyers will often be turned off by the prospect of having to upgrade software, equipment or administrative systems. Upgrading software, computer systems, or administrative tools will positively impact value.
- Clear Reporting: For owners, it’s important to understand the details of your financials before listing your business for sale. When a business profile shows consistent growth, it’s a major selling feature. It’s a value-add to be able to provide clear, concise financial statements (income statements, expense reports, balance sheets, tax returns, etc.) dating back for 3 to 5 years.
Experienced business brokers provide a detailed look at each of these contributing factors and how they will impact the value of a business as owners prepare to sell.
“A business is not a static image; it’s a mosaic. Each component of a business contributes to the overall profile. Understanding that each of these has a place is key to understanding its value”, says Jason Brice.
Understanding the Value of Your Business: How a Broker Can Help
With so much riding on the value of your business, it’s important to ensure that you are crossing every T and dotting every I before listing.
As you prepare to list your business for sale, a business broker is an asset in determining value and building a team of professionals to guide you through the complex process.
