How To Measure the Value of a Business Before Selling?
wileyfinancial October 27, 2022At some point in your business, whether after a few prosperous years or in the initial stage, you might think about the idea of selling it. Why? The reasons can be numerous. For example, you want to venture into something new or wish for an early retirement taking the proceeds of your business. But what is the price you are ready to sell your business?
The investors will quote a price. How would you know that they are paying you a fair price? You need to measure the value of your business before selling it. Hiring a business valuation service in Phoenix will help.
How Does Business Valuation Work?
You must understand how business valuation doesn’t work. You are wrong if you think that your business value is the total of your business assets. Investors are not paying you for your business assets. They are paying you for your transfer of ownership, which will give them the right to use the resources, make their own decisions, and earn more than what they have paid. They are paying you for your business’s earning capability, which depends on its goodwill. A company might have millions of assets, but if its sales are low, the company is not worth buying.
To calculate your business’s worth there are three different approaches. Professionals use these approaches and underlying methods to arrive at a value that fairly represents your business’s worth.
These three approaches are:
- Asset Approach
- Income Approach
- Market Approach
Asset Approach
It is not a very practical approach as it does not truly represent your business’s worth. The method involves totaling your assets, totaling your outside liabilities, and subtracting liabilities from assets. This method is often used at the time of liquidation of companies. Because when you are closing the business, you want to know is you have enough assets to settle your liabilities or what you will be left with once you settle all your liabilities. This approach is not suitable if you have a running business.
Income Approach
Most business valuation companies in Phoenix use this approach as it is the most practical. However, it will be difficult for you if you are not a CPA or a financial expert. It uses different methods like discounted cash flow, payback period, etc.
The basic notion behind this approach is whether the investors will be able to recover their money from the business or not. For example, in the payback period method, experts find out what time it will take them to recover their invested amount. In discounted cash flow method, the experts calculate what should be the present value of the business based on the future predictions of the business’s earnings.
Predicting a company’s financials involve considering market risks, market growth rate, industry growth rate, external factors, etc. You can’t calculate DCF or PBP without any financial knowledge.
Market Approach
It can be called the easiest way, but it is not. Finding a business that belongs to the same industry, offers the same services and products, has the same size, replicates you in every way, and has been sold recently is hard. If you find one, you cannot take the sale proceeds as it is. Instead, you need to take its sale value; make necessary adjustments and arrive at your business’s worth.
Essential Knowledge That You Must Possess
Being a businessman and a financial expert is different. You might know your business in and out, but you are not the right person when it comes to placing a value on it. But you should possess the required knowledge about a few things.
Historical Value Is of No Use
Even if you are using the asset method, you don’t use historical value but fair market value. Why? Because when you sell the business, you won’t receive the historical value but the market value that is prevalent at that time.
Intangible Assets Are Important
Intangible assets like goodwill are not recorded in the books, but they play an important role in determining a business’s value.
If your business is profitable and running successfully, and it has goodwill in the market, then after the sale, investors will gain from your goodwill. So, you need to place an amount on your brand image.
Also, assets like trademarks, patents, copyrights, etc., are crucial.
Liabilities
Once the business is transferred, all the liabilities of the business will be transferred with it. All loans and other financial obligations will be transferred. But if there is any personal litigation against you in your name, it won’t be transferred.
Know Your Business
You must know what you are offering to negotiate better as a seller. Know your financial statements and metrics inside out and be honest. Hiring a business valuation Phoenix service will help.
Final Words
Handing over your business to someone else is a huge decision. It will create a whole pile of responsibilities before you bid goodbye. Wearing the hat of a business valuer at such a crucial time isn’t the right decision. Hiring a business valuation company in Phoenix will lessen the burden and make it a smoother process.
