Selling a business starts with an accurate valuation
When you want to sell your California small business, the first step is to calculate its business value. You don’t have to be a business appraiser or an accountant to do it, but there are essential concepts to understand, so you are comfortable with the process and the outcome.
What’s important is to have a strategy. Selling a small business is a complex process, and without an in-depth plan, you can leave money on the table. Understanding the steps involved and seeking assistance from the right professionals can help you avoid this loss.
With the assistance of a business broker, you can sell your small business to strategic buyers. First, you will have to determine and understand the steps of selling a California small business:
- State the reasons for leaving and how
- Find out the value of your small business.
- Grow and continue to increase your small business value.
- Make all your financial statements and business documents available.
- Find motivated buyers to acquire your small business.
- Secure an agreement with the buyer.
- Sign the contract.
- Shift your small business to the new owner.
The Business Valuation Process
Most business owners have a number in their heads of what they think their small business is worth. However, many small business owners often get it wrong because they lack the necessary training, which is not part of their core expertise.
Also, bear in mind that a qualified and motivated buyer will have their own opinion. If a buyer needs to get finance from a third party, the lender will also have an opinion, which they will confirm as part of their loan underwriting process.
There are three ways you can get a report on the value of your business.
Broker Opinion of Value
Also known as a Broker’s Price Opinion (BPO), a Broker’s Opinion of Value involves a licensed business broker coming in to do a third-party evaluation of your small business to find the Most Probable Selling Price (MPSP).
They do so by using market data, the financial statements of your business, analyzing costs and assets, and researching and comparing your business’s income against what businesses have sold in your industry.
As part of the Broker’s Opinion of Value, they will use different approaches to value a business. There are only three approaches, and these are:
- Income approach
- Market approach
- Asset approach
Conclusion of Value or Short Report
For more formal situations or valuations that do not involve a court of law, a deeper analysis of the business and its industry trends may be required. This report is more detailed than a BOV.
Business Appraisal or Full Report
For legal transactions and litigation, you will need a complete report of your business. This is referred to as a business appraisal or full report and is typically prepared in response to demands from the IRS or a court of law, such as in the context of a divorce.
Beyond the value of your business, it also details the calculations used to determine that value and the steps taken to make those calculations.
The person who performs this appraisal needs to comply with both the Uniform Standards of Professional Appraisal Practice of the Appraisal Foundation (USPAP) and the Business Appraisal Standards of the Institute of Business Appraisers for their appraisal to hold any kind of authority.
Business Value
Now that you know about the different business valuation reports, let’s look at the best ways to calculate the business value. Your business broker will handle this entire process, but to get the process started, they will need the following documents:
- The tax returns of the business for the last 3 or 4 years.
- A current Year To Date (YTD) Profit and Loss for the business.
- A recent Balance Sheet.
The appraiser will have questions for the business owner, as they have knowledge that is an essential part of the business value.
First: SDE or EBITDA of the Business
The first part of calculating the business value is determining the cash flow or Net Income the business is generating for the last 3 or 4 years. Your business broker will complete this step for you, as it must be accurate; otherwise, the business valuation will be incorrect.
With the cash flow or Net Income of the business determined, the business broker will use this to calculate the all-important Seller’s Discretionary Earnings (SDE) or Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA).
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Second: Do At Least Three Calculations Using Different Methods
With the SDE or EBITDA identified, the business broker will then use the approaches described earlier—the Income approach, the Market approach, or the Asset approach—to derive at least some calculations that guide the valuation of the business. It would be incorrect to apply just one or two methods, as this could also distort the final value of the small business.
Third: Determine the Final Business Valuation
After the business broker has done at least three calculations, the final business value is determined. This includes putting weight on each calculation, as the business broker may consider one valuation method to be more relevant than another.
For example, I believe the Market approach is one of the most essential valuation methods. This method looks at what other businesses in the same industry have previously sold. That is, if the business is a manufacturing business, it makes sense to see what other manufacturing businesses have sold over the years that generate about the same gross revenue and SDE or EBITDA.
Typically, the business broker needs to buy this privately held database of information as it is not publicly available.
Get the Best Selling Price for your Company
In addition to the Market method, here are six different methods to calculate the value of a business. There are others, but be cautious about which ones are used, as the incorrect valuation method can distort or provide an inaccurate final business value. Additionally, each has its advantages, depending on the type of business you own, or, as explained below, some of these methods should only be used under specific circumstances.
Market Capitalization
This business value calculator involves using a company’s stock shares to determine its business value. To calculate it, you multiply the number of stocks owned on the market by their value.
For example, if you have 100 stocks outstanding and they’re valued at $1 per share, then your company would be worth $100 using this method.
Earnings Multiplier
This method compares future earnings to cash flow to determine a company’s value based on profit. It also accounts for interest rates and future investments consistent with the company’s current model.
Discounted Cash Flow Method
The Discounted Cash Flow (DCF) method is equivalent to the Earnings Multiplier. Still, it takes inflation into account and projects the business’s future earnings to suggest its current value. Inflation will impact a company’s value, making this a more precise representation of a company’s future value.
Times Revenue Method
For businesses with significant revenue streams in their market, this may be one of the methods for determining the business’s value. It is typically used only by companies with a considerable gross revenue, say over $50 million per year, or a publicly traded company. A business does not typically use it in the Lower Middle Market or Main Street.
The calculation in this method involves multiplying the revenue for a specific period (one year or six months) by various market factors. After these calculations, you will have a value based on your revenue (i.e., 5X revenue or 0.5X revenue).
The Book Value
The book value of your company is one of the more straightforward methods for finding business value. You can find it by subtracting the company’s total liabilities from its assets. Hopefully, this method is not used to calculate the value of your business, as it does not take into account the goodwill your business should have generated.
Liquidation Value
This is one of the most cut-throat ways to evaluate a business, and, once again, it is not a valuation method you want to use in your business valuation. A business typically uses this method when it is shutting down and closing its doors. After all the business’s assets have been valued and liquidated, the business closes.
Ready your Small Business for Sale
Before you begin your business valuation, keep in mind that over time, the value may no longer be accurate, as the business’s gross revenue and/or expenses are likely to change. Taking steps such as getting your financial statements in order, understanding your profitability, and consulting with Andrew Rogerson, a California-certified business broker, can all add value.
Final Take
As you can see, the process of valuing and then selling a small business is a complex and involved one. The best solution is to hire a business broker to help make the transition as smooth as possible. They’ll also help you sell and exit your small business successfully so you can leave your company privately with no drama or complications and, most important of all, move on to the next phase of your life.
Get started with understanding the 7 steps in valuing your small business.