Finding Business Value
What's the formula for determining how much you should sell a small business for?
QUESTION: Dan has a small business with $27,500 in assets. He is looking at selling the business and wants to know how to determine the value when you sell a business. Dave fills him in.
ANSWER: There are 3 or 4 ways to value a business. The worst-case scenario is the assets in receivables. That’s called book value, which means if you just close the business and sold off your stuff and collected the receivables. That’s the minimum that it’s worth.
Some industries have a multiple of gross revenues because there’s a standardized operating procedure in those industries. However, probably the most accurate way is just a multiple of your net profit of the business, after all expenses and management are paid. If I were looking at buying a small business as an investor, and I hired someone to do the job that you’re doing, what would it net then? In that case, you’d say that if net profit is $10,000 and I invest $50,000 into this business as an investor, I can expect to make 20% as a return on investment. That’s called a capitalization rate or cap rate. That can be good if I can get 12% by investing in a mutual fund and not having to think about it.
If you’re netting $15,000 a year after management is paid, and you’ve got a good name and customer base, and the assets are about $27,000, then that business is probably worth between $50,000 and $100,000.