How does the business valuation process work?
Buying a Business mentor Tom West responds to the above question from an inc.com user:
Here's the deal: If you're considering buying or selling a business that's worth less than $1 million or so, you're probably more interested in price rather than valuation. Many people use the terms price and value interchangeably. They ask, "What is my business worth?" when they really want to know what price the business will sell for.
The truth is, the terms are quite different. Basically, a business appraisal, or valuation, may produce a specific value necessary for some legal purpose. (See Inc. magazine articles "Business Valuation 101" and "It's Valuation Time" for more information about business appraisals and when it makes sense for privately held companies to have one.) A price, on the other hand, is what the market might pay for the business. Most buyers and sellers really want an idea of price. A valuation might be appropriate for a larger business, but the marketplace still almost always determines what a seller will get.
As for valuation procedure? There is no one specific procedure; there are many. And not one of them is perfect. Most valuations are based on a multiple of cash flow, and there are accepted rules of thumb for all kinds of small businesses, in all types of industries. They're not precise, but they can provide a good sanity check.
Keep in mind, however, that the numbers are not the only factor to consider. Some businesses are more in demand than others. For example, a restaurant that's open for six hours a day and serves dinner only will probably sell for more than a restaurant that's open 24 hours a day if everything else -- including financial performance -- is equal.
Using outside professionals when you're buying or selling a business can be invaluable. When in doubt, talk to someone who owns a similar but noncompetitive business. The information you receive will be well worth the cost of the lunch or dinner.
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