Imagine the day has finally come for you to sell your business. Maybe you’re ready to retire and move to the beach—or however it is you envision your ideal retirement. You’ve had a good run, but now it’s time to enjoy the fruits of your labor.
You might be wondering, “What is my business really worth in dollars and cents?”
Before getting into valuation, I want you to begin with a more fundamental question: Would someone want to buy your business in the first place?
To sell your business (or your shares in a business), you need a business that someone would want to buy in the first place. As obvious as that sounds, you’d be surprised how many business owners fail to grasp what this really means.
Have you ever dealt with a business that is so completely tied to the owner that it can’t survive without him/her? In this kind of business, the owner has a hand in everything—working on the end product or service, managing employees, overseeing the books, keeping customers happy, and so on.
I don’t know about you, but this isn’t the kind of business I’d want to buy. If the owner is the business, there’s no business I can buy from that person. I’d be afraid that without the owner around, the business would easily collapse.
For your business to be marketable, make sure you’re building it in such a way that you don’t have to pull every lever or micromanage everything to keep it afloat.
Understanding Business Valuation
Now, let’s talk about valuation. Business valuation can be an incredibly complex subject, but I’ll give you some key points to remember.
First, a prospective buyer will want to know about your profitability. You might be generating decent revenue, but how much do you have left after subtracting your costs?
Second, a prospective buyer will be interested in your business’s net worth. To calculate your net worth, simply add up all of your assets and subtract all of your liabilities. Raising your net worth, then, is a matter of increasing your assets and decreasing your liabilities.
To raise your net worth, my article on cash flow provides a lot of tips that can help.
Return on Assets
A third area that will interest prospective buyers is how well you’re utilizing what you have in the business. For example, something called “return on assets” (ROA) gives a percentage of how profitable a company’s assets are in generating revenue. It can tell you how efficiently you use assets to generate earnings.
The formula for ROA is:
ROA = Net Income ÷ Total Assets
Return on Equity
Along the same lines, Return on Equity (ROE) is another factor worth considering. ROE is a profitability ratio from the investor’s point of view, not the company’s. It indicates how much money is derived from the investors’ investment in the company, and not the company’s investment in assets or anything else.
The formula for ROE is:
ROE = Net Income ÷ Shareholder’s Equity
Don’t get too hung up on the formulas, though. The important thing to realize is that raising the value of your business is a matter of making more profits, reducing your debt load, and better utilizing your assets.
In evaluating your business, buyers will also want to know what your numbers have been historically. Have things been trending upwards or downwards? The past three years tend to be the most important time period.
And for any future projections you tout, those need to be realistic or buyers will be suspicious.
Last but not least, remember that valuation methods can be helpful tools; however, at the end of the day, your business is only worth what someone would actually pay for it.
To recap, make sure you’re building a business someone could buy in the first place (i.e. that’s not completely tied to you as an individual).
And to raise the book value of your business, look at the methods and formulas I provided above. Work on improving each of the elements that you know buyers will want to examine.
Don’t wait to get started until a month before you’re ready to sell. The sooner you get started, the better.
Have a business question you’d like me to answer? Send me an email at email@example.com.