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What’s your Business Worth?

PizzaCoins-298x300It is not too difficult to find out how much your car is worth or indeed your house but as a small business owner one of your personal assets may well be your business.  Would you know how much it is worth if you needed to sort out a divorce, an overdraft or a loan?  If there was an Inland Revenue dispute, or for probate analysis or even bankruptcy, would you know its worth?  Or what if you simply wanted to exit the business at some point in the future, would you know its worth?

Before you can put your business on the market, you need to figure out its value. Price your business too high and you’ll scare off potential buyers. Price it too low and you could be left wanting.

Think about what you can learn from the experts on Dragon’s Den, in terms of getting the right investment level for the value of the business that is given away!  It is easy to over value the worth of your business based on the effort you have put in to getting it to this point.  However, all parents think their babies are beautiful when … some are just plain ugly!

Judging the value of a business is not rocket science, there is however and art to it.  The only time you will really know how much your business is worth is when a buyer writes you a cheque.

Different Methods for Calculating Value

A.   Market Approach is based on the Principle of Substitution “A buyer will pay no more than that which he or she would have to pay to purchase an equally desirable substitute.”

The market place lives and dies by this principle.  It is the method currently used in Real Estate transactions and is most easily understood by both buyers and sellers.  It is based on two questions:

• Which Seller has the best price?

• How do I find the buyers who will pay a better price?

Direct Market Data Method (DMDM) is best used when valuing a main stream business.  It is dependent on availability of market transaction data.  There is little UK data available in the UK on the value of small business sales or purchases.  This is because it is rare that any two businesses have exactly the same qualities.  The DMDM is a subjective evaluation.

This is best used to compare a company to the sale of other privately held companies in the same or similar line of business.  It requires too much analytical information to use on deals for less than £1M but essentially takes into account Size, Profitability and Financial Strength. To reconcile differences in comparisons ratios are adjusted and then the value is calculated

B.  Income Approach is based on the Principle of Future Benefits “Economic value reflects anticipated future Benefits”Income valuation approach. Analyzing the business’s revenue is one way to come up with a fair price for the business. This assumes that the buyer is looking at a business as just one more type of investment competing with stocks, bonds, real estate, and so on. The question then becomes “What kind of return can the buyer expect from an investment in this business?”

For a financially motivated buyer this means the value for the business is today’s value of the future earnings or benefits of the business.  Such Future earnings are discounted for the time it will take to realize them and the risk that they may not be realized.  The longer it takes for an investment to be liquidated the less desirable it is in the present desire while a future desire may be OK with an investment that may take a while to liquidate.

C.  Asset Approach is based on the Principle of Substitution “A buyer will pay no more than that which he or she would have to pay to purchase an equally desirable substitute.”  This approach puts a price on the business by totalling up the value of all of the assets.  That includes tangible ones such as property, vehicles, furniture and including intangible ones, such as intellectual property. 

This approach is usually based on your assets’ resale value, not how much it would cost to replace them. 

There are 3 Methods to this approach:

1.  Excess Earnings Method 7 Step Process, estimates Value of Goodwill and added to value of Tangible Assets

2.  Net Asset Accumulation Method; This being the most useful when fair market value (FMV) replacement cost of assets represent most, if not all, of the value of the business.

3.  Rule of Thumb.  This should be used to value and price thumbs!  And thumbs only! (Relies on 1 size fits all)

Calculating Most Probable Selling Price (MPSP)

Fair Market Value (FMV) of tangible assets + FMV of intangible assets + FMV of Good Will +/- adjustments.  The MPSP is based on the assessor’s opinion of facts considered and, does not necessarily represent a reality or a FMV.  The MPSP of a business should of course be defensible.

If you’ve skipped to the last paragraph, it is unlikely that you are really interested in selling your business as a going concern.  However, if you have and are then do re-read the post from start to finish.  If you need help then get in contact …

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