Do you really know what your business is worth? One of the sayings I really like is, the value of your business is what someone else is willing to pay for it.
There are six pieces to knowing how to value your business or for that matter, any business, because these six pieces will be just as valuable if you’re trying to buy a business, as well as you’re thinking about transferring your own business. And that’s what we’re going to cover in today’s video.
Today we’re gonna to talk about how you can figure out what your business is worth, and it’s only take a few minutes of your time. You know, the truth is, for most business owners knowing the real value of their business is a mystery. One of the sayings I really like is, the value of your business is what someone else is willing to pay for it. And that’s what we’re going to cover in today’s video.
I bet you would then agree that knowing the value of your company is something that is really important. Most business owners I know, think their business is worth much more than it really is.
What if I could show you an easy way to understand how a buyer would look at your business?
Then you would have a better idea of what your business is really worth.
Hi, I’m Josh Patrick, founder of The Sustainable Business, and cracking the cash flow code and a few zillion other programs we put together over the years, that helps business owners like you create a sustainable business where the business will last past you. I’m also the author of Sustainable: A Fable about Creating a Personally and Economically Sustainable Business.
You know, there are six pieces to knowing how to value your business or for that matter, any business, because these six pieces will be just as valuable if you’re trying to buy a business, as well as you’re thinking about transferring your own business.
First, know that your business will be valued based on the free cashflow it produces, not sales.
Now, every industry has what I call the dumb-dumb number which is some multiple of sales that people would pay for the business. When I was in the vending business, it used to be 40 cents in a dollar. Meaning, if your business did a million dollars, you could expect to get about 400 thousand dollars for the business.
Now, these dumb-dumb numbers actually often have a reason they exist. It’s said, if you back in to a multiple cashflow, the number sort of makes some sense but, your business might create a lot more cashflow than the average bear or it might create a lot less cashflow than the average bear.
If you’re creating a lot more cashflow, well that number of multiple sales is not going to be very valuable for you because you’re probably getting a lot for your business but if it’s a lot less, you’re going to get less for your business or you’re going to have offers that are not what you thought they should be because, you’re thinking about a multiple of sales not a multiple of free cashflow.
Second, you need to figure out what your free cashflow is.
So, here’s how I do it when I look at a cashflow. I take my profit, I add back what is called EBITDA, which is earnings before interest, taxes, depreciation, and amortization. So in other words, I take the depreciation out and I add that back to the cashflow.
Now, I also take, add back expenses that the business has for the owner that the new owner is not going to have, but at the same time, I have to talk about what’s the cost in replacing the owner of the business or the person who’s selling the business.
Now, too often I see business owners say, “well, you know, they’re not going to have to replace me, so all the money can be added back to the cashflow”.
It’s not true. Unless you are completely an absentee owner and you never do anything of value for your business, you’re going to have to add back the cost of what the replacement is for you in the business.
Third, I want you to understand who your potential buyer is.
Now, in a public company the value of the business is pretty narrow because we have public marketers valuing it every single day. But, in a private business, your value can vary by as much as serval hundred percent. Now, a guy named Rob Slee, who I really like a lot, is really a great thinker about this, has come up with a concept that he calls Value Worlds.
In your business lives is several value worlds. Now value world depends on who the buyer is.
If it’s a finale buyer it’ll be one value. If it’s a strategic value where you’re selling to a competitor, it’s a different value. If you’re selling to your managers, still a different value. If you’re selling to your children, still a different value! Or, if you’re liquidating another value all together.
So you see the value of your business is going to really vary depending on who the buyer is. So you need to really understand is, who is a potential buyer for this business? Same thing goes for when you’re buying a business.
Are you a strategic buyer or are you a financial buyer?
You need to know the difference between the two because it’s really important when you start evaluating a business.
Once you get that free cashflow number and you know who your buyers are going to be, then you can start thinking about, what is the multiple for my business.
Now, for most private businesses, the multiple goes from between three times cashflow to six times cashflow. So if you have a hundred thousand dollars in free cashflow into your business, the business can be worth somewhere between three and six hundred thousand dollars. Now, you’re probably not going to get a six time multiple if your business only does a hundred thousand in free cashflow a year. The truth is, the larger the business, the higher the multiple.
Now when you look at public companies that do billions of dollars on sales, you’ll see their multiple is around 14 to 25 on an average basis. It’s really rare that you’ll see a privately held business, even come close to that, for the multiple that’s sold typically, three to six times. Now, there are things that can improve that multiple and the two big things that can improve that multiple is:
do you have a recurring revenue stream? And are you operably racially a role in the business?
If you’re not important in the business, then somebody can buy your business and not worry about you but if you are actually integrated in to the success of the business, and there are a lot of big businesses that’s true, then you’re going to get the type of multiple or even have sellability for your business that you think you should have. So those are two things that you really need to be thinking about.
Now, if you’re thinking about selling your business, it’s great to say, “okay, I have a million dollars in free cashflow, I’m going to get four million dollars from my business” or, “I have five hundred thousand dollars, I’m going to get two or three million dollars from my business.” Well you really don’t get to take that and put it in the bank because there’s two things you have to factor in.
One is the selling cost which is the cost for the broker who’s seeling your business, your accounting cost and your legal cost, that’s typically around five to ten percent. Then you got taxes which typically for a business is somewhere around 30 or 40 percent.
So you’re going to lose somewhere between 40 and 50 percent of your sale to taxes and fees.
And if you think, for a second, that the two million dollars you sell your business for you get to put in your pocket, you’re really need to think again because if that’s your plan, you’re going to be really, sorely, underfunded when it gets time to leave your business.
Then finally, here’s something in which I think you really need to be thinking about. If you’re going to be holding paper for the sale of your business, you need to act like a bank.
Too often I see people selling their business and then they tell me, “well, the buyer doesn’t want to give me a personal guarantee”. And my comment always is, “you cannot sell to them”. So if you really think that holding paper is something you want to do, and I’m going to encourage you not to do it unless you have to, you have to act like a bank. Get the security agreement that a bank would have. In fact, go to your bank and ask them for some security agreement forums that they use and use those with your buyer.
So those are the things that you need to think about when you’re trying to figure out what the value of your business is.
So why don’t you leave a comment below? And while you’re at it DOWNLOAD our infographic that shows you to success path on cracking the cashflow in your business.
And this is Josh Patrick, thanks for stopping by. I hope to see you back here really soon.