How to Value a Business for Sale.
Know Your Target Business’s Value, Risk, and Pitfalls.
Table of contents
Use a 3rd Party Business Valuation when Buying a Business
Owning and operating a small business can be extremely rewarding. For some, doing so represents the opportunity to create an enterprise with growth potential. For others, it reflects the chance to build a valuable asset for themselves and generations to follow.
Regardless of your motivation for entering business ownership, you should keep in mind that you may be able to do so without having to launch the business yourself. You can still benefit as an entrepreneur by buying an existing business.
Buying an existing business is a common and popular option among potential entrepreneurs. The practice has especially become common as millions of baby boomers retire and sell their businesses.
By buying an operating company, potential entrepreneurs can avoid startup costs and growing pains. Problems that often accompany you when creating businesses from scratch. Still, finding a business for sale to execute the deal can be complex, risky, and overwhelming.
Here are a few initial steps you should consider making to effectively launch your search for an existing business.
1. Determine what kind of business you want to purchase
With so many industries and evolving sectors of business emerging, you should determine what type of business you would like to buy. Usually, we advise to purchase a business in an industry you are somewhat familiar with. This is because it may be difficult to succeed in an industry where you have had little exposure to or experience in before the sale.
You may also consider working with a consultant to determine what industries are especially thriving in your local market and narrow your search around that insight.
2. Understand why the business is being sold
Once you have an industry in mind, you can proceed with the search by researching online business marketplaces or working with a business broker to identify what businesses are for sale. Either way, you should understand why a business is being sold.
This is because although there are various simple reasons — like retirement or an upcoming move — that may motivate an individual to sell their business, there may also be troublesome reasons spurring the transaction. For example, a business owner may sell their business to avoid existing business debts or inventory difficulties.
When considering purchasing a business, be sure to ask the current owners what problems the enterprise is currently facing or what you should expect to encounter. Consider whether you have the skills and abilities needed to overcome those challenges if you purchase the firm.
3. Analyze the business’ worth
Arguably most important, you must consider the true economic worth of the business and understand the steps taken to maximize value. You and the seller can seek independent valuators, like BA FL|GA|HI, to help you determine which appraisal service best suits the situation.
Although the valuation methods used to conduct the appraisal may vary, the factors included in such analysis remain the same. Often, we assess the financial health of a business by considering its team, assets, earnings, growth, and losses within the context of the firm’s specific industry.
Appraisers often employ a few approaches to evaluate an existing small business and determine its fair market value.
Those Valuation Methods include:
Asset Approach to Valuation
Although imperfect, this method determines the value of a business by taking the difference between the company’s assets and liabilities. Assets analyzed include physical items like machinery, property, and raw materials in addition to intangible items like intellectual property. Next, assign a monetary value to each asset. We then sum each of the assets’ values before any subtracted debts or liabilities.
The valuation that this approach yield is likely a lot lower than the business’ true worth because it fails to consider expected revenue and earnings. Regardless, it is a great starting point for appraising a business.
Market Approach to Valuation
This approach determines the value of a business by considering the market prices of similar assets or businesses that have been recently sold or are in the process of selling. It also considers the value of the business based on geographical location and area. It is especially helpful if you are interested in determining what price a business should be purchased or sold for within your local market.
Publicly available data regarding company comparisons and transactions are usually utilized for this method. Adjustments should be made for different quantities, qualities, or sizes when comparing assets.
Price-To-Earnings Ratio (P/E)
The P/E ratio, or multiples of profit, is a method often used to evaluate small businesses’ worth with an established annual record.
Expert valuators use this method to inform forecasted return growth through prior profits. A higher P/E ratio would be used for companies with high forecasted return growth or repeat earnings. For example, if the P/E ratio of three is used for a company that makes $500,000 in post-tax earnings, the enterprise would be valued at $1,500,000.
Although the calculations used to reach the valuation are straightforward, expert valuators like BA FL|GA|HI can suggest the correct number for your P/E ratio. This is because the P/E ratio often varies from business to business. Startups, for example, often have high ratios because they are high-growth companies. More established companies, on the other hand, like auto shops or local insurance agencies, experience less drastic growth and will likely have a lower P/E ratio.
Using a Valuation When Buying a Business Conclusion:
Purchasing a small business helps can help you avoid the costs of launching a business. But buying an existing business also imposes unique risks and challenges. Understanding a company’s true value and worth can be extremely helpful as you strategize and execute a potential sale.