Many factors determine value of business

One of the most common questions that I get from business owners is "what do you think my business is worth?" The simplest answer to that question is that the business is worth what a buyer is willing to pay for it.


Of course that is an oversimplification, and does not take into account many of the nuances that go into what the marketplace says creates value.

Understanding how businesses are valued, why and how buyers prescribe different values based on the sizes and types of business and what an owner can expect to receive if they eventually decide to sell their company is an important consideration for any business owner.

A business's value is really a combination of many factors such as the company's sales, earnings, performance, market outlook, personnel, net book value, fair market replacement value of assets, and intangible assets like the company's image, reputation and goodwill.

In my office is a hardcover book that contains over 800 pages on business valuation methodologies.

I was required to purchase the book several years ago ($249 to the best of my recollection) as part of a class I took on business valuation.

Needless to say it can be very complex to determine a business's value, which is one of the reasons that I personally don't perform valuations for my clients and rely on independent third party experts that specialize in that field.

Since most of my clients are looking to sell their business I want them to have an objective expert opinion of the businesses value, so that when they make a final decision to sell their company they are informed about the decision.


This valuation approach will typically be most applicable to businesses that rely heavily on hard assets in order to make the business function. In valuing these types of asset-intensive companies, the most common methods, include adjusted book value, book value and liquidation value.

The adjusted book value is determined by revising the asset's book value to reflect the cost it would take to replace the assets in their current condition, in essence placing a "market value" on the business assets.

The book value considers the figures from the company's financial records, as depreciated at the time of the sale.

The liquidation value is the amount that could be realized if all assets -- equipment, furnishings and inventory -- were sold separately.


In general most businesses valued using this approach will be valued based upon some multiple of the businesses earnings. The income approach takes into consideration the company's level of earnings using a capitalization rate, a discount rate or a multiplier.

Several income approach methods are frequently used. Each method requires a level of earnings and a conversion factor to translate the earnings into a company value.

Selecting the proper level of earnings -- after-tax, pretax, discretionary or cash flow -- will vary based upon the size, type of business and the perceived desirability or risk inherent to that particular business or industry. The proper conversion factor -- discount rate, cap rate or a multiplier -- will also vary based upon the specific business being valued and is critical to calculating a reasonable value.

For example, larger companies are typically valued using a multiple of EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization), while smaller owner-operated businesses tend to be valued based upon some multiple of the owners net income


The market approach sets a value based on the values of other businesses that have been sold. Determining the market value involves researching the sale prices for similar businesses in a geographic area.

Since most private business sale transactions are not available in the public record, in some cases, finding a company that is similar to the business being valued may be difficult.

It is important to note that when using the market approach the businesses must have similar characteristics. Just because the industry is the same does not mean the Market value will be the same. For example a manufacturing business with a patented product may be worth more than the same manufacturer that makes products that are not patented, or a single dry cleaner will be valued differently than one with multiple locations.

I believe having an appraisal performed by an independent third party using these methods is important for the business owner because it gives a benchmark in which to determine the viability of any offer that a potential buyer might propose.

Ultimately the marketplace will tell us what the business is worth. What a buyer is willing to pay for the business is the ultimate business valuation methodology.

Now you don't have to buy that $249 book.