6-Step Plan for How to Determine the Value of Your Business
How to Determine the Value of an 8, 9, or 10-Figure San Francisco Bay Area Business
Evaluate These 6 Factors Before Hitting the Negotiating Table with Potential Buyers
As you get deeper into the process of preparing your 8, 9, or 10-figure business for sale, the complexity of the task begins to reveal itself. But if you want the maximum value for your merger or acquisition, you don’t want to skip any of these steps.
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Table of Contents
Determining the value of your business is the 4th step in the business exit process. Before we get to the six factors that will help you finalize the value of your business, you’ll want to work through the first three steps, which you can access below.
Step 1: Use this 17-point checklist to develop your business exit strategy
Step 2: The 5 critical members of your business sale team, and 8 tasks they will help you complete
Step 3: Learn to tell the story of your business to a buyer in 5 steps
6 Steps to Determining the Value of Your Business
1. Determine Your Cash Flow
Cash flow is, in simple terms, what’s left after you have paid your expenses and your payroll. You will need your accountant’s help to crunch all the numbers, which is one reason why you must assemble your team (step 2 above) before trying to value your business.
But to give a general idea, the formula for determining cash flow is this:
Cash flow = Net income + Noncash expenses + Changes in working capital
Your net income is simply your total revenue minus total expenses. Calculate working capital by subtracting current liabilities from current assets.
Cash flow, much more than revenue or net income, is what informs the buyer of your business’ ability to expand, grow, pay off debt, and continue to be profitable well into the future. You can find out more about cash flow here.
2. Evaluate Your Risk
Risk encompasses all the things that could potentially threaten the value of your business. Some of them are internal, dependent on how well your company has been managed, and how well the new buyer manages it after the merger or acquisition.
Other risks are external, mostly outside your control, but still must be considered because they affect the confidence with which your buyer will purchase your 8, 9, or 10-figure business.
Here’s a rundown of the major risks, both internal and external.
Internal Risks Affecting Business Value:
- Mix of revenues
Is your business heavily reliant on just a handful of products or services? Or, do you have a broad mix of revenue generators? The more narrow your revenue mix, the higher the risk to a buyer.
If conditions change, such as new regulations, shifting customer preferences, or economic changes, and your one or two most valuable products fall out of favor, your business could greatly suffer.
- Location
For some businesses, moving locations would be next to impossible. Others are much more nimble. If the geographical and economic landscape around your business changes in significant ways, your business can either suffer or benefit.
For instance, in Seattle, 15 years ago the downtown area had several old and under-developed areas. But now that Amazon has taken over whole swaths of downtown, employing thousands of workers who make high salaries and fill up dozens of new high-rise apartments and condos, the area looks completely different, visually and economically.
Some businesses from the earlier era have been gobbled up or had to move. Other businesses have thrived amid this new development. And many new ones have opened up, especially high-end restaurants.
Some of this is external – outside your control – which is why location is also listed as an external risk below. But it’s also internal if your business has the ability adapt to changes in your local area.
- Staffing issues
Do you have stable, loyal employees or extensive turnover? A buyer will likely see high turnover as an increased risk, because the buyer will have to devote more resources to recruiting and retaining employees.
- Marketing processes
Whichever marketing processes you are currently using, there are always others you could add in to your strategy. If your marketing is heavily dependent on one channel, such as Facebook for instance, a buyer will perceive that as an increased risk.
Just like revenue mix, if your primary marketing channel loses effectiveness or disappears altogether (which can happen easily with Facebook, as they continually change their algorithms without warning and have nearly shut out certain industries), your business can greatly suffer.
A buyer will want to see multiple marketing channels producing healthy ROI, new leads, or both. Or, even if those aren’t in place, if the capability to add new channels exists within your current structures, this can still be seen as a risk-reducer.
- Cost structure
How much of your costs get devoted to labor, travel, materials, bonuses, and product development? Every business is different. Some have more flexibility in their cost structure, others less.
- Dependency on owner
When a business’ revenue depends highly on the owner, perhaps because it is built around their personality or notoriety, it will be perceived by a buyer as having higher risk. Can the new buyer sustain your business at current levels once you’re not there?
This is a major question to ask yourself. Smart business owners will ask it well before looking for buyers, because if you find your business is too owner-dependent, there are some things you can do to change that before trying to sell your 8, 9, or 10-figure business.
Your team of experts, assembled in step 2 of the business exit process, should be able to help with this.
- Customer profile
Examine your customer base. You also explored this in step 3 when learning how to tell the story of your business. Customer loyalty, percentage of new and returning customers, average transaction size, demographics – these and many other factors contribute to the long term outlook of your business.
This also integrates with your marketing plan in numerous ways, which we don’t have time to explore here.
External Risks Affecting Business Value:
- Technology
Technological change affects all businesses every year, some much more than others. But this change is largely out of our control – even if your business is creating some of that technological change.
- Location
As explained above, location is both an internal and an external risk.
- Economic and marketing conditions
The most obvious external risk, your business must always grapple with changes in economic and marketing conditions. When Google changes their algorithms for organic search, you can’t control that.
But if you acquire a high percentage of your leads and sales through Google, you have to respond to these changes or your business will suffer.
Likewise, global and national changes in economic growth, tax policies, trade, and other areas can affect your revenue and costs in ways you cannot control.
The more susceptible to these risks your buyer perceives your business to be, the lower they will value it in a merger or acquisition.
3. Project Your Long Term Growth
To the best of your team’s ability, you should be able to present your buyer with reliable long term revenue and cost projections.
What is your debt situation? What new products and services do you have in the pipeline? Any upcoming joint ventures or expansions into new markets?
Plus, the longer your history, the more reliably you can reassure your buyer of your 8, 9, or 10-figure business’ long term health and viability.
If you can demonstrate how your business has performed through various economic and political conditions, you can alleviate some of the risks listed in section 2 above – especially the external ones outside of your control.
4. Specify the Transferability of Assets and Revenue
Expanding on the question of how owner-dependent your business might be, you want to show which revenues and assets are most easily transferable regardless of ownership, and which are less predictable.
For instance, do you own any land or equipment? Transferring that should be relatively simple.
Do you have a line of books written by you that generates leads and sales for the business? Once you retire, those book sales may decline, so that represents a potentially less transferrable asset – though it depends on how your marketing is structured.
5. Use Industry Valuation Standards
One common valuation standard is EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization.
This goes beyond net profits, and includes things like tax payments, interest payments on loans, and equipment leases. These other assets increase your value. For instance, suppose that as part of the business sale a particular loan gets paid off.
The money you were spending on that loan now becomes revenue. Or suppose you had a business travel budget of $15,000,000 a year. If the new owner decides they only need to spend $5,000,000 per year on travel, that $10,000,000 difference now gets folded back into revenue.
So your travel budget is not necessarily a negative expense in the same way as something like materials costs. You can add some expenses back into your business value. In other words, how much revenue will the new owner make if they don’t do all the same things you did that cost your business money?
The higher you can raise your EBITDA, the higher your business will be valued. Once you’ve determined your EBITDA, you then determine what to multiply it by, and that becomes a possible business sale price.
Again, your team of experts will help you with the details, whether you use EBITDA or some other method to quantify the value of your 8, 9, or 10-figure business.
6. Assess the Current Market Environment
Consider your competitors. How replaceable are your products and services? What kind of demand do you foresee for your products? How could new regulations, or automation and technology interfere with your long term revenues?
Do you anticipate a bidding war among multiple buyers because you’re in a ‘hot’ industry? Or might you have to scramble just to attract one legitimate buyer?
These and many more questions must be asked as you evaluate how your business projects to perform in the current and future marketing environment.
Need Help with Your Business Exit Plan?
Pillar Wealth Management has extensive specialty experience working as the financial advisor on many business sale teams. While this is just one of five key roles on your team, you will want someone who has sat in the room during numerous planning and negotiation sessions.
Someone who knows what to ask, the potential risks, and how your merger or acquisition fits in to your long term financial plans. Plus, we know many experts who can fill the other positions on your team. Reach out to Pillar for Merger and Acquisition Help today
With your business valuation completed, you are now finally ready to start engaging with potential buyers in negotiation. That’s the topic for the next article in this Business Exit Series.
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