If you are a business owner, eventually you may consider selling your company, whether due to retirement, downsizing, consolidation or narrowing your niche. This undertaking is likely not something you will want to tackle on your own. You may want to enlist the help of a business broker. Similar to a real estate broker, a business broker assists an owner in determining a reasonable asking price, finding potential buyers, and negotiating the deal.
The first step, determining a fair market rate for your business, is a complex process and is crucial if you want to ensure a timely and lucrative sale. While you could use online calculators to estimate your business’s worth, an impartial, personalized, and thorough professional analysis is much more accurate.
You should be aware, however, that a business broker is not the same as a business appraiser, who is trained and equipped to place a true value on your company. A broker, by contrast, establishes an initial asking price that he or she thinks the market will bear. Depending on the method used, the broker will take into account multiple factors, such as your level of earnings or the sale prices of similar companies, as well as outside resources and the opinions of trusted experts.
There are three primary methods brokers employ to reach an asking price – the market approach, the income approach and the balance sheet approach. Your broker will work with you to select the one that is best suited to your business and the state of the marketplace.
Regardless of which approach he or she takes, your broker will make sure you understand the reasoning, as well as the factors, that led to the final estimated value.
If you’ve ever sold a home before, the market approach may remind you of how your real estate agent came up with the listing price for your property. He or she researched comparable houses in your neighborhood or within a certain radius that had sold recently to determine what local buyers were willing to pay for a home like yours. With that information, your agent could present to you a figure or a price range that would be reasonable to expect to attain when you sold your home.
A business broker who uses the market approach to land on an asking price for your business will take a similar tactic, looking at recent sale prices of local companies like yours. If you own a dry cleaning business or an ice cream shop, it might not be challenging to find comparables to make an accurate sales estimate. But, if your category of business is more unusual or in a niche, such as a public relations firm that specializes in museum clients, the market approach could be the wrong approach for you. Your broker might suggest one of the other two main approaches, which depend more on your own business’s history, status, and projected cash flow.
The income approach examines a company’s earnings and earnings potential to arrive at a listing price. This approach is generally considered more precise than the market approach because it is tailored to your business, rather than relying on similar companies’ recent sales data. This sales data can be limited if you’re a unique enterprise or if your circumstances are different from your competitors’, in terms of reputation, cash flow, intellectual property, inventory, and the like.
There are several different methods under the umbrella of the income approach. Each method uses your business’s earnings level and applies a conversion factor to compute an approximate market price.
The discounted cash flow method, using its simplest model, divides projected future earnings by the growth rate, minus the required rate of return for the investor, to calculate the business value. More complicated models employ a multi-tiered formula with a varied growth rate.
The capitalization of earnings method simply divides annual future earnings by the rate of return, without factoring in a growth rate.
In any case, the earnings themselves can be after-tax, pretax, cash flow, or discretionary. Your broker will examine your business to determine which figure to use.
Balance Sheet Approach
The balance sheet approach, like the income approach, has many different valuation methods. The primary ones are the book value, adjusted book value, and liquidation value.
The book value is what its name implies, the company’s financial record value, including any depreciated assets. The adjusted book value considers the cost to replace existing assets at their current state of repair and also deducts all liabilities. The liquidation value is often the lowest amount of these three, as it looks at the individual assets’ worth rather than the value of the business as a whole. Your business’s intangibles, like your employees and your customer base, are not factored into the equation. If you plan to dissolve your business, however, the liquidation value method could be the most practical for you.
When you are ready to sell your business, for whatever reason, consulting a broker should be part of your process. The sale of your business is too important, both financially and personally, to guess at an asking price or to allow your emotions to sway your opinion. Enlisting the assistance of a third party, such as a broker, is highly recommended.
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