Certain concepts are really hard for me to grasp. Infinity. Light. The space-time continuum. Retirement. Business valuation.
As a business owner, I can get by without fully understanding the meaning of “infinity” and “light-year.” But “business valuation” might hit home, especially when it comes to understanding “retirement.”
Business owners hold something of value — ownership in a business. And, in the life of an owner, there typically comes a time when he/she becomes willing to part with his ownership in exchange for some things he/she values. Typically, the thing of value is money. But in every deal there are many deal points. Many more than just money.
When selling a one-of-a-kind asset, how do you estimate “fair price”?
How do you know whether an offer is “high”?
How do you determine what price is absolutely the highest sale price possible?
We all have heard that companies sell on “multiples of earnings.” As such, the talk at the country club or trade conference has quickly moved to who sold for the highest multiple. We hear the multiples, but we almost never hear the definition of profit used or important elements such as the deal terms.
The buyer of a business, having selected his minimum required rate of return, justifies purchase price of a “going concern” by the cash he expects the business to generate.
In an attempt to project what the future might hold for a business, the buyer looks at many things. One is past performance of the business. Historical income statements provide useful, factual information about income, expense and resulting profit for particular periods of time. Given that the buyer is interested in the future rather than the past, the buyer seeks to understand historical income and expense only as a means for predicting the future. As such, many income and expense entries will need to be removed or modified. One type of expense that may be removed or added back to historical profit is extraordinary expense items.
When we estimate the value of a business, we are estimating the price at which it could be sold. Of course, buyers will only buy a business when it makes “financial sense” to do so. A purchase makes financial sense when the proposed price and terms allow for the following three tests to be met:
The majority owner of a business was presented with a new business opportunity that was not exactly related to that of his core business. He had lots of questions and asked for our help. This case study will walk you through the simple analysis that we facilitated.
Business valuation can be complex. But as with most projects a good start is to build a solid foundation. The foundation of a good appraisal will be the answers to four simple questions.
Want to know the value of your business? Pose the question to your closest friends and advisors. First, write your answer down. You will be amazed at the range of responses. Go one step further and ask each person how their answer was determined.
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