Some of the most profitable small-business owners have no idea what their company is worth.
That’s the experience of Michelle Seiler-Tucker, author of Sell Your Business For More Than It's Worth and owner of Better Business Brokers in New Orleans. “It always surprises me to ask clients, ‘How much do you think your business is worth?’” Seiler-Tucker says. “Most of them look at me like a deer in the headlights.”
Identifying an accurate value for your company is critical—and not just in the event of a sale or buying out a partner, or when attracting investors and creditors. Understanding how small businesses are valued helps companies be more efficient and prepare for the future, says Roger Murphy, CEO of Murphy Business & Financial Corp., a business brokerage with 150 locations.
Murphy says small-business owners often come up with a rough figure of their company’s worth based on erroneous thinking. “They usually say it’s 10 times the revenue, based on what they’ve read about the sale of public companies,” Murphy says. “They’re not analyzing the right numbers.” Instead, most small businesses will sell for about 2.5 times their net profits, he says.
Some tips for small-business owners putting a value on their company:
• For tax purposes, most small businesses try to make profits appear as small as possible. When preparing for a sale or to find investors, the goal is to make sure all profits are on the books, to make sales appear as large as possible. Every dollar not on the books saves the owner 30 cents in taxes, Murphy says, but costs $2.50 in a future sale.
• Earnings should include the owner’s salary and benefits, which many small-business owners do not issue to themselves, instead just taking home what is left after expenses.
• Look at it from a buyer’s point of view. “Lots of business owners estimate their business is worth much more than it actually is because of the time they’ve put in,” Murphy says. “You can own a business for two days, and if it’s profitable, it will sell for a lot. People buy a business based on what they make and what they hope to make.”
• Include brand recognition. “Intellectual property is often overlooked,” Seiler-Tucker says. “Think about it: How much are the names ‘Coke’ or ‘Nike’ worth?”
• “Business valuation is not a one-size-fits-all process,” Tucker says. Worth is impacted by less tangible factors, including whether the company has a strong product mix, a desirable target audience, whether the sector is on the rise or decline, and standards specific to the particular industry.
Professional consulting can be a huge asset for business owners. Thorough valuations for small organizations can cost between $5,000 and $10,000 for full appraisals, such as those required by courts in cases of divorce and dispute, and for some lenders. However, Murphy says many sole proprietors’ needs can be satisfied with reports costing $500 to $1,500, which will include some recent comparisons, market value and a suggested price.
Finding comparable business sales is key to an accurate valuation, and often requires calls to competitors and peers, which can render the process public. “For a lot of businesses, confidentiality is the No. 1 priority,” Tucker says. “That’s impossible without a business broker.”
Owner and CEO
Company: Foreign Accents, an Albuquerque, N.M., rug maker
Reason for valuation: Buying out husband in a divorce; as a business tool
Takeaway: Valuating the company makes priorities clearer.
We started in 1984, and were running a successful business, but didn’t know what the outside world thought it was worth. Eight years ago I was buying out my now ex-husband and business partner during our divorce, and I had to figure out the company’s value.
I started by reading business books on valuation, then went to my accountant for help, and later had lunch with a few business brokers to pick their brains. My ex-husband and I eventually came to a number—we both felt we were cheated, which probably means it was fair.
I found the whole process very interesting, and it made me want to always know my business’s value and what goes into it. In my case, I travel a lot for business and am in different countries for a third of each year. A lot of that travel is mandatory for work, and a lot is discretionary, but both of those figures go into the value of the company.
Knowing your business’s worth gives you an objective, non-emotional way to gauge how well you’re doing compared with the previous year and with other companies in the marketplace. I use BizEquity.com, an online platform that automates the valuation process. It has access to data I wouldn’t—unless I was willing and able to pay a lot of money for it.
Knowing my company’s value helps me set priorities and understand how I’m doing against industry standards. Recently I ran my BizEquity numbers and realized I had too much inventory. The very next day I cleared out my old merchandise and put on a sale. Those valuation figures stare you straight in the face. You can go a long time ignoring your figures, but they are critical to running a successful business.
Owner and Founder
Company: Brad Kuhn & Associates, a public relations firm based in Orlando, Fla.
Reason for valuation: Bringing in a partner
Takeaway: The process validated the owner's decisions and poised the firm to grow.
I started this business early in 2010 and soon brought in my wife. We’ve grown 100 percent each year, and the sponge got full. We needed to bring in a high-powered partner to help grow the company. I am the business development and client relations guy, and my wife oversees operations and staff development. In order to grow substantially, we needed someone to manage the workflow.
We identified the right person who is the perfect fit, and it is a great opportunity for him. But we couldn’t pay cash for him, so we offered a package that mixes salary with equity, which is why it was important for us to value the company.
I have an MBA, so I looked at our cash flow and came up with a dollar amount. But this partner is very conservative, and we couldn’t get him in without a third party valuating us. So we enlisted a business broker who used five different methods to evaluate the past three years of business.
Valuating a business like ours is tough. We’re a consulting firm, so we don’t have a big inventory, plus we’re a young company, which penalizes us in the sales price. Nonetheless, the broker’s figure came within 5 percent of mine. The new partner’s lawyer looked at the figures, beat them up, and we agreed on a number in the middle.
I project this partner will help us grow by 500 percent over the next year or two. But perhaps an even greater advantage is my confidence from getting such a high sales price from an objective person. As an entrepreneur, you’re making decisions based on 80 percent of the information you need if you don’t know what your business is really worth.
Knowing our market value has given us a leg up in making business decisions.
Company: Pacific Tugboat Service, headquarters in San Diego
Reason for valuation: Buyout of a partner
Takeaway: Valuations helped the owners run a more efficient business and prepared for potential sales.
I’m a tugboat guy, and my partner is a tugboat guy. We’re not financial guys. We understand the basic concepts of assets and debts and sales volume, but didn’t understand how the factors of those add up. We’ve been through three valuations in the past 10 years, and each has been an education that helped us run our business better.
The most recent valuation was last year, when two of the partners bought out the founding partner, who retired. This time there weren’t any surprises, because the past two—done for potential buyouts that fell through—taught us so much about our company’s worth. All three partners agreed that the valuation was important to make everyone comfortable with the numbers.
The process has been invaluable in how we think about and run our business. For example, our very expensive marine equipment is not considered an asset because we rely on it to run the business. I thought, Since we have $20 million in equipment and $2 million in debt, we’re worth $18 million. But that’s not how Carl Sheeler of Business Valuations Ltd. in San Diego saw it. Machinery in a company like ours is needed for daily operations, so it is valued differently.
We had always run the business with concern for cash flow, not toward building a business from an outsider’s point of view. Today we have a better understanding of what investors look for. In the past we thought our tax strategy was more important than our valuation strategy. Now we take a less aggressive tax posture in order to raise the value.
Using an outside valuation service was really important. These are unprecedented times in terms of the economy and sales of businesses like ours, and Sheeler really had to do his research to find comparable valuations and sales. That is not something we could have done on our own.