Business Valuation

One of the key aspects of a formal succession plan is determining the value of your business. There is a lot to consider including different valuation methods, timelines, and your buyer’s perspective, which we overview below. Ultimately, we advise getting a formal Chartered Business Valuation done to ensure you maximize the sale of your business.

Business Valuation Methods

There are several methods to valuate a business. The right one for your business or farm is determined by your type of business, as well as the type of sale (share vs asset) you are using for the transition from one owner to the next.

A share sale is when a corporation sells a part or 100 percent of its shares to a new owner. The business has to be set up as a corporation. This sale method is usually preferred by the seller because it transfers all liabilities and can have some tax advantages. An asset sale is the sale of business assets used to run your business, like equipment and customer lists. This is usually preferred by the buyer to mitigate risk and the assets can be written off over time on the balance sheet. This is the only option for sole proprietors. For both methods, there are financial, tax, and legal implications that you should research.

Here is a list of the most common types of valuations in order of how commonly used they are for small businesses. We detail below the types of businesses that typically use each valuation type, but a Chartered Business Valuator (CBV) can help you determine the best formula for you. We recommend reaching out to a CBV at least 24 months before selling your business to ensure their findings can maximize your sale.

1. Discounted Cash Flow (DCF) Method

The DCF method is based on a projection of the future cash flows of the business. This method is most commonly used when a business owner is selling an operating business to a new owner and takes into consideration inflation to determine a net present value.

2. Book Value

The book value method is based on taking the value of the shareholders’ equity of a business from the balance sheet statement: total assets minus total liabilities. This is commonly used by businesses that have stopped operations or are considering an asset sale option.

3. Earning Multiplier

The Earning Multiplier is a calculation that can be used by medium or large businesses, and franchises, that are selling to professional buyers like Private Equity Groups. It is used to compare companies that have reliable profit and consistent input costs to predict future revenue.

4. Times Revenue Method

The Times Revenue Method is a calculation that can be used in niche markets like tech where professional buyers believe they can grow the revenue quickly through some form of market advantage or when raising venture financing. The equation is a total revenue times multiplier for that industry and economic environment.

5. Market Capitalization Method

The Market Capitalization Method is based on taking the company's share price multiplied by the total number of outstanding shares. This is most commonly used by publicly traded companies.

Timeline

The timelines for your sale can impact your valuation process on two fronts:

• Market conditions can change dramatically year over year, so if a business owner has more than three years before they want to sell, we do not usually encourage spending a considerable amount of money on a business valuation because a lot could change before they go to transition.

• Take into consideration your desire to get full compensation value for your Goodwill, which are your intangible assets like copyrights, processes and training systems. In this case, you will need to mitigate the risk for your buyer by staying on for a longer mentorship period to ensure these intangible assets are fully realized for the successor.

Buyer Perspective

A business owner could ask whatever they like for a business, but that does not mean someone is going to pay that amount. There are multiple factors that come into play when a buyer is looking at a business, primarily:

1. What is of real value in the business and what is its ability to generate a return on investment?
2. Will the opportunity cost of capital be returned in five years or less? Too often we hear business owners say: “If someone came in with more money, energy, and a little bit of marketing then this business would be a huge success.” Although that may be correct, that potential buyer could invest their money and time into a number of different activities and realize a return. If the business will not pay for itself in five years or less, then a buyer is unlikely to purchase it.
3. Is it bankable? The biggest barrier to purchasing a business is finding financing. Many institutions will not lend on goodwill because it's risky. As a business owner, you have years of experience managing the ups and downs, plus have those personal relationships with your customers. The potential buyer may really love the business and can see the opportunities, but if they are using leveraged financing, then a business owner has to understand that lenders may require some safeguards like vendor financing or other conditions.

How to maximize the final value of your business

There are many factors which contribute to the value of the business. A business valuation is not the same as an asking price and the dollar amount is not the only thing in the Purchase/Sale Agreement that should be taken into consideration.

Engaging a Chartered Business Valuator (CBV) after completing your formal succession plan can help you negotiate a better valuation. It is important to keep in mind that a business valuation is a range that the business could be worth, and different components of the business could help you drive up the total return on investment that you receive from your business or farm.