Putting a Value on the Apples of Your Business
Quick – how much does an apple cost?
If you took even a moment to answer the question, you pictured an apple and assigned a relative value based on quantity (is it price per pound? Per unit?), quality (how old? Is it organic?), and availability of alternatives (Honeycrisps are my favorite, but are Cortlands cheaper? Hmmm, maybe bananas are more in season…)
If I asked you the value of your equipment, inventory, or furniture, you’d go through the same process, making a snap judgement based on these factors.
The value of an intangible asset, on the other hand, can seem arbitrary. How do you know what your customer list, a brand name, or a reputation is worth? If you said, “pay a broker or accountant to tell me”, that’s not a bad answer (it’s their job, after all), but understanding how to use business market comparables will help you ask the right questions.
Using business market comparables is a similar process to physical assets: identify similar businesses recently sold or currently in the market, make adjustments based on how they compare to your business, and deduce a reasonable market value. To get an apples-to-apples comparison, focus on two things from your Income Statement – Gross Income (an indicator of business size) and Cash Flow (an indicator of business strength).
To use a market comparable, take their Gross Income or Cash Flow, divide it into the Sale or Asking Price, and take the resulting Multiple. Applying either multiple against your business performance will give you a relative market value.
Like pricing a house based on acreage or pricing a house based on the number of bedrooms, pricing based on Gross Income is distinct from pricing based on Cash Flow, and often provides two different values. How do you know which method is more appropriate?
Let your likely buyer decide.
When to Use a Gross Income Multiple
If your Buyer is likely Strategic or Synergistic, use a Gross Income multiple. A strategic buyer intends to roll your operation into their own; they may have their own accountant, different insurance plans, intend to consolidate the advertising… any number of expenses can change. Don’t try and predict what their bottom line will be; it’s different for each potential buyer, and your predictions will rarely be accurate.
Another way of looking at it – with their own infrastructure, they are only buying your customers & market share demonstrated in your Gross Income. Why would your business efficiencies & expenses matter?
When to Use a Cash Flow Multiple
If your Buyer is likely Buying a Job, use a Cash Flow multiple. A buyer intending to step into an owner/manager role is purchasing their future earnings – the surplus cash flow that the business produces. They will use the same systems, methods, and structure to run the operation, and will expect all the expenses to be inherited.
Regardless of who you think the buyer will be, consider both multiples, and work with your Broker to ensure the price is market-appropriate and appealing to the right audience.
At the end of the day, you know the apples of your business better than a Broker ever will, and by working alongside them, you ensure your best possible outcome.
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