How Much is Your Small Business Worth?

While some may describe it as a labor of love, establishing a successful small business can require years of grueling toil over long days and short nights. After investing money, time and effort into starting a business and helping it grow and succeed, many small business owners look to sell their business and enjoy the fruits of their labor in the comfort of retirement. Before they can market their company or weigh any offers they may receive, business owners must confront the central question: How much is my business worth?

When marketing a small business, the price one sets is paramount. No one wants to undervalue their business and lose some of the benefit of the hard work that went into getting it off of the ground. Price your business too high, however, and potential buyers will simply walk away. Even if you are lucky enough to receive an offer, having an idea at the potential market value of your business will allow you to weigh the value of the offer and, potentially, provide ammunition for a possible counter-offer.

Of course, placing a value on a small business requires more than simply adding the values of each of the business assets — such as equipment, inventory and real estate — and subtracting the liabilities. Some assets of a small business are of great importance to a potential buyer but difficult to value. For instance, a well-developed customer list, experienced employees or a prime location can rank among the primary reasons a buyer may be attracted to a business, yet may defy conventional valuation methods. These intangible assets — often referred to as goodwill, or the value of a business as a going-concern — can easily outweigh the value of the "hard" assets a business might possess.

When they need to determine a value of assets such as these (or of their business as a whole) the owners of companies large and small often turn to business appraisers. Usually accountants, business appraisers rely on a number of valuation techniques that have developed over the years to establish a potential market price of a business. While a formal appraisal can be expensive and time-consuming, it can help business owners make wise, informed decisions on the final disposition of the companies they spent so long building. It is important to keep in mind, however, that even the most thorough business valuation cannot establish a "set" market price: As with most things, the value of a small business is, ultimately, whatever a purchaser will pay for it.

Common Business Valuation Methods

Like setting the price of an item for auction — albeit on a much larger scale — determining the value of a small business requires one to weigh several competing factors. It is no surprise, then, that a number of business valuation methods have developed. In fact, the wide variety of methods available is one reason why a professional is helpful in this process. The following are only a few of the more common valuation methods that one may employ:

Asset Valuation: Usually based on physical assets such as inventory and fixtures, this method is often used for manufacturing business or sales/retail business. Commonly, under this method one totals up the value of all assets, including both tangible — inventory, furniture, improvements to physical space — and intangible. The value set for each physical asset can be either the resale or the replacement value, but is often the former.

Income Valuation: This method is often used by businesses that have comparatively few physical assets, such as service organizations. Under this method, one analyzes the company's revenue, with the assumption that a potential buyer will view the company as but one investment in a portfolio, much like stocks or bonds. The value of the business is determined by the potential return on investment for the buyer.

Rules of Thumb: While not favored by many financial analysts, this can encompass any of a number of rough estimates of a business' value based on industry averages. Essentially, this approach entails seeing what other companies similar to yours have sold for, then using this as a baseline for your business. This works best for sales that have occurred recently. Unfortunately, because small businesses tend to have fewer comparables, you're unlikely to find a recently sold business that closely matches yours.

Article provided by Hammerle & Finley Law Firm.