Many business owners want to know “What is my company worth?” Unfortunately, there is no easy answer.
The minimum value of any business is its liquidation value – the amount that would be received if all assets were sold and all debts paid. However, that is not a simple calculation based on the balance sheet of the business. Each asset must be considered separately – what price will this asset bring if I have to sell in 3 months?
In general, used office furniture, computers, and the like have surprisingly little value. Highly specialized equipment may retain more of its value. Accounts receivable become hard to collect. Debts, on the other hand, generally require payment in full without discount, especially bank debt.
Types of buyers
More value is generally achieved if the business is sold. In general there are two types of buyers:
Financial Buyers: Financial buyers will continue current company operations with minor changes and include current company managers and employees. Financial buyers price the business base on its cash flow – cash flow is frequently calculated as the average cash flow for the past three years. Financial buyers either:
- Use a multiple, generally between 3 and 5, of cash flow to determine the price they will pay, although some businesses sell at a lower or higher multiple, or
- Calculate the largest loan that can be serviced by that cash flow over 10-20 years.
Many industries have a rule of thumb to estimate value. For example, the rule of thumb to value insurance agencies is 1.5 to 2.0 times annual net commission income.
Strategic Buyers: Strategic buyers will combine all or part of the company with their other operations to achieve cost savings, an expansion of their product lines, or both. Frequently strategic buyers will move the entire company and incorporate it into their existing operations. At a minimum, strategic buyers consolidate certain functions, such as accounting and sales. Such consolidation produces cost savings to current company operations, which increases the cash flow generated by the company. That enables strategic buyers to pay a higher price than a financial buyer.
No matter who is the prospective buyer, cash flow is key. Buyers prefer audited, or at least reviewed, financial statements that do not require too many adjustments to calculate cash flow. Expenses such as excessive compensation, compensation to family members contributing little, generous fringe benefits to owners and family members should be eliminated prior to offering a company for sale.
Extrinsic factors also influence value, including:
- Interest rates (high interest rates result in a lower value)
- The expected life cycle of the company’s products,
- Whether easy replacements are readily available for the company’s products
- Whether the economy expanding or contracting
Determining “what my company is worth” is a difficult task. The only true answer is that value is what a willing buyer and a willing seller say it is.