How Much Is My Business Worth? A Basic Guide to Find the Value of Your Company
After you sell your company and collect what you hope is an eight, nine, or ten-figure payoff, you may be looking to retire, start a new company, go on vacation, something else, or all of the above. But that’s a long way off if you’re still running the company today. First, you must figure out what your business is worth.
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Clients frequently share with us how the knowledge gained from this book helped provide them tremendous clarity, shattering industry-pitched ideologies, while offering insight and direction in making such important financial decisions.
The good news:
You can make pretty good headway right here, and we’ll walk you through the basic process in a bit.
But, determining your business worth is complicated if you want to get an accurate figure that you can reasonably expect a buyer to pay. You will need a good team working with you, including a business lawyer, CPA, transaction attorney, financial advisor, and probably an investment banker if the company is worth over eight figures. You can download our Exiting Strategies Guide Here to learn more.
Pillar Wealth Management’s founding financial advisors have been part of many such teams for ultra high net worth business owners over the last 30 years. We focus not just on getting you the best deal from the business sale itself, but on what will happen to the money after it transfers to you. You want to avoid big tax bites on your windfall, and to do that requires an artful understanding of ultra high net worth finance and investments. Set up a meeting with one of our expert financial advisors.
Here’s the basic process for determining the worth of your business.
Basic Formula: What Is My Business Worth?
The simplest way to express your business worth requires only two numbers – your EBITDA and its multiple. Put those together and you have a reasonable and fairly standard method for presenting the value of your business to potential buyers.
Here’s the math version:
EBITDA x Multiple = Business Worth
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. We’ll get to the details in a moment.
But as an example, suppose you calculate your EBITDA to be $50 million, with a multiple of five. That would mean you could expect to sell your business for about $250 million.
Step 1: Determine Your EBITDA
To find your EBITDA, you will ideally want data from the last three years for sales revenue, cashflow, operating expenses, cost of goods and services sold, employment costs, and all other expenses.
Your accountant can help you work through the details using your statements, records, and documents.
Why use EBITDA and not just the P&L?
The reason EBITDA is superior is because it takes into account other costs, expenses, and financial aspects of your company that wouldn’t show up just using those basic sales numbers. It is a more accurate figure for the worth of a business, and is used in most industries.
The next step will flesh this out.
Step 2: Normalize Your EBITDA
Once you have the basic figure, you want to ‘correct’ it, so to speak. In the normalization process, the value typically increases, so this is a critical step in the process of calculating your business worth.
What you’re doing here is looking for expenses that you are paying because you own your business, but that the new owners will not have to pay.
For example, loan payments.
If you’re making monthly payments on loans for anything like equipment or property, and part of the business sale process will result in those loans being paid off, then the new owners will not need to pay those expenses. Thus, you can remove them from your EBITDA.
Or, you may be refinancing some loans as part of the business sale, resulting in lower monthly payments. Subtract the difference from your current payments, and add this back in to the EBITDA.
See how that works?
Here’s another example:
As the owner, you may be incurring business travel expenses such as conferences and in-person meetings with clients. But the new owner isn’t required to take those trips. So, you can usually add back in a lot of your business travel expenses and increase the EBITDA.
Some business owners also don’t take a salary in the traditional sense. You might be paying yourself directly out of your profits. But once you sell, the new owner isn’t going to keep paying you, so that too can be added back in to the EBITDA.
Again, your business accountant and an experienced financial advisor consultant can help make sure you don’t miss any opportunities to come up with the highest possible EBITDA.
Also, your investment portfolio will become much larger once you sell your company, and the government will want a big piece of your pie. To find out how to minimize taxes on your investment portfolio –get this free guide, 7 Secrets to High Net Worth Investment Management, Estate, Tax and Financial Planning.
Step 3: Find Your Multiple
Unlike the EBITDA, the multiple does not get calculated from a fixed or standard formula. This figure is agreed upon by the parties involved in the business sale.
All sorts of factors can affect this figure, and we’re about to look at a bunch of them. The stronger and healthier your company is, with more evidence of stability and growth over a longer period of time, the larger multiple you can expect.
What kind of multiple can you expect in your business sale?
Typical multiples range from three to six, but plenty of businesses of all sizes have sold for ten times their EBITDA, sometimes much more.
Let’s look at some of the factors that affect your multiple:
• Business growth
Did your business have a banner year last year? Great, but how was it the few years before that? One great year will raise questions. What led to such a big year of growth? Did you change anything in your operations? Pay off a big expense? Launch a new product? Get lucky because of external factors out of your control – right place at the right time?
If you can show sustained revenue growth over at least three years or a sustainable reason for last year’s big growth, you can usually command a higher multiple.
• Industry trends
Would your industry be described as growing, stagnating, or declining? Are lots of new companies being launched in your industry? What is customer demand looking like? Healthy growth prospects lead to a higher multiple.
How are you stacking up compared to current competition? How likely is that to change? What if someone else innovates in a way that pulls customers away from you? If you have a couple key competitors growing very quickly and you’re holding pretty steady, that might lead to a bit of a lower multiple.
• Years in business
Companies just five years old generally have a harder time proving their worth and commanding higher multiples than companies that can show years of stability. This is not always true of course – your type of industry plays a big role here – but it is a factor in agreeing upon a multiple.
• Number of employees
Payroll size speaks to stability as well, but it also represents a sizable expense that the new owner will have to manage. Companies that tend to command the biggest multiples often have very high revenue figures but small staffs. This is one reason tech companies often win the big headlines when it comes to their business worth.
• Brick and mortar, internet, or both
Is your company internet-based, location-based, or do you draw revenue from both? There are pros and cons to each in terms of finding your multiple, but you can expect this to come up in your business worth negotiations.
• Management structure
Do you have a well-functioning leadership structure in place, or would it be described as chaotic and dysfunctional? Do you even know? How tuned in to your leadership team are you?
If there’s a lot of turnover in your highest level positions, this might be interpreted as a red flag that would lower your multiple. Employee feedback surveys can play a helpful role here, because you can learn how the mid-level and lower level employees perceive their superiors.
• Company culture
A healthy company culture is distinct from management structure, but you can evaluate it using the same survey if you so choose.
If your employees love working for you and feel valued and appreciated, and believe they have opportunities to grow in their careers at your company, that can translate to a higher multiple. No one wants to buy a business and then have half the team quit within the first few months.
• Automation – not dependent on owner
One of the most destructive factors in your multiple is the level of dependence your business has on you. An owner-dependent business raises questions about stability:
What will happen after you leave?
If you haven’t done well at delegating tasks, training your leadership team, setting up automation processes and structures, and other systems that will just keep humming even when you’re not there, your buyer may be hesitant to pay a higher multiple.
• Transfer ability of assets and revenue
Will there be any difficulties transferring assets like equipment and buildings, or will this be relatively easy? Likewise, a business that brings in a lot of recurring revenue that just remains in place no matter who is running the ship will often be able to get a higher multiple.
• Technology risks
There are businesses, and then there is technology. Amazon and the rest of the internet have upended many older business models. New inventions can render previously essential products obsolete.
A buyer will likely want to look at how exposed and vulnerable your company is to innovation and regulations from other industries, competitors, and even governments.
If you get the majority of your leads from Facebook, and then Facebook changes their algorithm or terms and you can’t use it the way you used to, you’re in deep trouble. That kind of over dependence on one platform or tool is akin to being too owner-dependent.
Probably the most famous example of technology disrupting a business sale is the AOL-Time Warner merger back in 2000. At the time, AOL paid $182 billion to merge with Time-Warner and create a media and internet empire. In very short time, the worth of the new company plummeted.
It remains one of the most costly deals in history.
And technology was one of the main causes of the fall, though certainly not the only reason. You can read more about it here.
AOL was a dial-up internet service with tens of millions of customers. But within a few years, broadband internet took over, rendering dial-up a dinosaur before it had barely left the nest.
Is your company vulnerable to technological advancements? It’s not always an easy question to answer, but it may play a role in the multiple that determines your business worth.
More of a factor for companies with physical locations, location can play a big role in the multiple you agree to with a buyer. Is that part of the city or state growing in population, or declining? What are the crime trends in the area? How is the local government treating businesses like yours?
For companies renting office space, they sometimes have the ability to relocate their leadership teams. Boeing famously took its leadership team from Seattle to Chicago some years back. Other companies have a much harder time relocating, if there were a reason to do so.
For your company, this might or might not matter.
• Variety of revenue sources
Is your company dependent on just a few revenue sources, or do you bring in money from a greater variety? The fewer revenue sources you have, the more at risk your company is of suddenly losing large percentages of revenue.
Maybe your biggest customer goes out of business and represented an outsize portion of your revenue. Maybe you only have three core services, and one of them becomes obsolete because of a competitor or a technological innovation.
Greater variety of revenue sources conveys greater stability and a higher multiple.
• Customer profile
Lastly, what’s up with your customers?
Do you have a track record of customer loyalty? What are your customer demographics?
Get some data on things like average order size, purchase frequency, and things of this sort. Show your buyer how your customers behave, and you can demonstrate a strong and healthy business that is backed up with data.
After You Calculate Your Business Worth…
This process will take time, and part of it will take place in your business sale negotiations.
So start with determining and normalizing your EBITDA, and then start thinking about these factors that will affect your multiple. Look at similar companies in terms of industry, size, and other considerations that are comparable to yours.
Selling a business isn’t just about getting the highest possible value.
It’s also about getting the best possible deal for YOU. That means the details of how the money gets transferred, the taxes you’ll pay or find ways to minimize or avoid, the terms and timing of the sale, and many other considerations.
An experienced wealth manager who has been on many business sale teams will be a powerful asset in getting you the best possible deal.
Are you looking to sell your business within the next 3-5 years?
Set up a call with Hutch or Chris, our founding wealth managers, each of whom have over 30 years of experience exclusively serving clients with high and ultra high net worth.
To be 100% transparent, we published this page to help filter through the mass influx of prospects, who come to us through our website and referrals, to gain only a handful of the right types of new clients who wish to engage us.
We enjoy working with high net worth and ultra-high net worth investors and families who want what we call financial serenity – the feeling that comes when you know your finances and the lifestyle you desire have been secured for life, and that you don’t have to do any of the work to manage and maintain it because you hired a trusted advisor to take care of everything.
You see, our goal is to only accept 17 new clients this year. Clients who have from $5 million to $500 million in liquid investable assets to entrust us with on a 100% fee basis. No commissions and no products for sale.
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