Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

What's your business worth?

- by Alan Duvall 

Published in Dayton Daily News February 26, 2006  

Owners often devote lives to growing companies – yet have no clue what these most valuable of assets are worth. 

Determining a business value is much more than a simple tumbling of numbers using back-room formulas.  No one method dominates the process and the conclusion can change given the circumstances. 

Fair market value is defined as the cash equivalent price if the property would change hands between a willing buyer and seller, neither being under a compulsion to act and both having reasonable knowledge of relevant facts. 

Values can change with the circumstances.  Certainly a business is worth less in liquidation mode than a structured sale given reasonable time. 

Values can change with the buyer.  A buyer stepping into the seller’s shoes will typically pay less for the company than a competitor’s synergistic purchase of sales attenuated with the elimination of unnecessary overhead. 

Valuation methods vary with each industry.  Some industries sport simplistic “rule of thumb” formulas.  For example, CPA firms often sell for “one times annual sales”.  But beware – such simplicity carries risks of miscalculation.  Two CPA firms can possess similar sales volumes yet generate vastly differing bottom lines.  Rule of thumb formulas are useful but should never be used to the exclusion of alternative verification methods. 

Industry databases of actual company sales have been developed in recent years providing clues to prices paid in real market situations.  Market-driven methods tend to work best when a large number of transactions are available for homogenous businesses such as franchises.  Unfortunately, the method often breaks down due to lack of reported transactions. 

The capitalized earnings method utilizes projected earnings multiplied by a factor derived from investor risk criteria.  Earnings equal net income plus existing owners’ wages less “reasonable” owner wages.  Reasonable wages are measured by the earnings capacity of new owners or wages of managers hired to run the business.  A buyer is acquiring a business, not a job, and economically is only willing to pay for business income after payment of reasonable compensation for services. 

Once a business value is determined via a combination of the above methods, it is wise to test the conclusion with an old world methodology – can the buyer afford the business?  Assume typical loan terms and determine if the business can pay for itself in five to seven years. 

All those fancy formulas are useful, but cash rules the world.  If the business cannot internally repay negotiated acquisition debt, it’s time to rethink the deal.

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.