How a Buyer Determines the Value of a Small Business

So you have decided to Buy sell Business. But how realistic is your opinion of the value of your business? What is a small business worth? A business is worth exactly what someone is willing to pay for it and not a penny more. There are times when the same company will have multiple offers and the owner will see drastic differences in the buyer’s valuation of the business.

Why is this?

The valuation of a small business is mostly a reflection of risk. Most sellers have a valuation that is typically higher than the buyers. This is because most sellers know and understand their business’s pros and cons. Sellers typically believe in their business and its prospects for growth. Sellers know their financials inside and out. There is no mystery.

But buyers do not have this history or emotional attachment. Most buyers are learning about your business as they go. This means buyers will value the business based on an industry standard multiple – but that multiple is determined by the buyer’s perceived riskiness of future cash flows.

You see, risk and valuation are an inverse relationship. Examples of factors that can reduce the perceived risk and increase the perceived value are:

• If the business has a long history of revenues and profitabilityrn• If the business’s financial documents are in order and are consistent with the financial operations of the businessrn• If the business has a wide variety of loyal customersrn• If the business has a wide variety of supportive vendorsrn• If the business has a good location and can remain in place through a long-term property leasern• If the business transaction can be financed through an SBA approved lenderrn• If the seller has adequate support staff and is not a ‘one man show’
• If the seller is leaving the industry and will sign a non-compete agreementrn• If the buyer has similar skills as the seller

Most businesses will be valued based on a multiple of your cash flow based on previous comparable transactions in your industry; however, these multiples (typically between 1.5x and 3x) can vary greatly. The key to maximizing the value of your business is to minimize the perceived risk to the buyer. Take time early on to put yourself in the shoes of the buyer. Review the bullet points above and put together a story (with supporting documentation) of the business that addresses each of the topics.

Let your accountant calculate your profitability. Do your homework on comparable sales. Calculate the economic value of the business. This is the science part of the valuation.

But selling a business for the max is both a science and an art. The art is showing the buyer that your business is less risky than the next. Reduce the buyer’s risk and you will be paid handsomely for your efforts.