How much is your business worth?

It can feel like a loaded question when you're talking about a company you've poured your heart and soul into. Setting the right asking price, and being completely objective about it, is one of the most challenging decisions sellers make in the sales process. The effects can be long lasting as well. If you set your asking price too high, you might not get enough buyers interested, but if you set it too low, you'll know you left money on the table.

In the second quarter of 2016, the median asking price of sold small businesses was $222,000, according to the BizBuySell Insight Report. But setting your company's asking pricing isn't as simple as looking at the national average or even your local average. Factors like industry, location, company size, assets, etc. all influence a company's value. While a professional appraiser or business broker can help narrow in on a specificasking price, there are several methods sellers can employ to get a ballpark estimate:

3 Valuation Methods-

  1. Liquidation Value. This approach determines the value of the company's assets as if it were forced to sell all of them in a short period of time (typically less than one year). Although this valuation method works best for capital-intensive businesses, it's a useful exercise for nearly all sellers.

    To get a liquidation value, owners must make a list of all their company's physical assets including inventory, equipment and furnishings. Then you must consider the acquisition cost, use, age and condition to estimate a realistic value of each item as if you were going to sell them today. The total of these values is one way to measure the value of your business. However, it's important to note that for most business, this value will fall short of your company's actual worth since it doesn't take into account cash flow, intangibles like brand recognition and other factors.

  2. Earnings Multiple Valuation. Multiples are ratios of business value to key financial indicators like revenue and cash flow. Multiples vary according to business type, geography, business size, and a wide host of other factors. Business valuations typically range from one to four times annual cash flow, but can exceed this range under certain conditions. In Q2 of 2016, the average multiple of revenue for a small business was 0.61 and the average multiple of cash flow was 2.22, according to the BizBuySell Insight Report. When evaluating multiples, consider factors like if your business has positive revenue and profit trend, if it has brand recognition, features exclusive products or territory, and if it's prohibitive for other entrepreneurs to start similar businesses from scratch.

    If your business has one or more of these features, then you can justify using a multiple at the higher end of the spectrum. Another way sellers can hone in on a multiple range and, thus, a potential valuation range for their business, is by looking at comparables and their selling price multiples. Business-for-sale websites like BizBuySell offer inexpensive tools that allow you to look at a database of past small business sales.  

  3. Income-Based Valuation. Most experts agree that an income-based valuation is the best means of valuing a business. However, this calculation can be rather complex. To start, owners should put together financial documents from the current year as well as the previous three years. Documents to include are the income statement, which details the gross revenue, expenses and bottom line profits or losses; the cash flow statement, which shows how much money moved in and out of your business and how business assets changed as a result; and the balance sheet, which shows the value of all tangible assets and liabilities.

    An accountant or bookkeeper can help you organize these documents. A professional can also help you recast your business income into a statement of owner's cash flow or statement of seller's discretionary earnings (SDE). An SDE presents the full earning power of your business after adding back one-time, non-recurring purchases and discretionary expenses not essential to business operations. It is this full earning power of your business that is, ultimately, of key concern to prospective buyers.

Should you get a professional valuation?

While a professional valuation isn't necessary for many small businesses, employing the help of a professional appraiser or business broker offers reassurance that you're setting the right price. What's more, many buyers are less wary of asking prices backed by independent valuations. Appraisal costs vary depending on the level of accuracy needed and the complexity of the company. Research firm IBISWorld says business valuations in the U.S. can cost anywhere between $3,000 and $40,000. For many small businesses, this fee can feel like money well spent.

When it comes to selling your business, everything from your key financial statements to the paint on the walls impacts its value. Sellers should make sure to organize their financials, and, of course, keep their business well maintained if they hope to sell it successfully. 

Published on: Aug 15, 2016
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.