April 2011 Selling a Business
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Selling a Business

By Steve Strauss. ARCHIVE:

One thing small business owners like to noodle on once they become successful is their so-called 'exit strategy' - that is, what will they do with the business once it is time to move on Options abound: Close the doors, give it to a child, and of course, sell it.

If that last option intrigues you, let me suggest that you begin by reading a great book written by a colleague of mine, John Warrillow, called Build to Sell. In it, John explains the various hoops you need to jump through in order to create a business that others want to buy and then how to do it.

Beyond that, by way of primer, when it comes to selling a business I think that there are basically three questions to consider:

1. What does the business own? A business that has invested a lot of money over the years in assets is obviously more valuable than a business that has not. Assets can take many forms. Of course they cover things like trucks and equipment, but also must take into account valuable contracts, intellectual property rights, and goodwill (i.e., the reputation that the business has in the community.)

Sellers tend to overvalue goodwill and buyers tend to undervalue it. The important thing then is to realistically calculate the value of the name and brand of the business.

2. How much does the business earn? Again, the same principle applies - a business that makes a profit of $100,000 a year is much more valuable than one that nets $35,000.

3. Are there any intangibles to consider? What makes the business unique, profitable? Do you have a great location, a favorable lease, great employees, a long-term contract? These are the last things to consider.

These three items are then taken into account and used to determine the value of your business and there are essentially three ways to go about doing so. The first is called price building. The second method is called return on investment. The third is the multiplier.

Price building is a valuation method that simply looks at the hard facts - assets, goodwill, leases, real estate, etc. Essentially what you do here is list every asset and give it a reasonable dollar value. For example, yours might look like this:

  • Real estate: $150,000
  • Equipment: $15,000
  • Inventory: $25,000
  • Goodwill: $10,000
  • Total value of the business: $200,000

Return on investment (ROI) looks at the business profit, per year, to help the buyer see what the return on his investment will likely be. For example, let’s say that you decide that $200,000 is the asking price. Is that fair? Using the ROI method we would see that:

  • Net profit: $100,000
  • Business sale price: $200,000
  • Return on investment ($100,000/$200,000): 50%

Using this method, and these numbers, the buyer would be making out like a bandit, getting a 50% return on his investment. There are few investments out there that allow a 50% ROI. Thus, a higher amount for the business is probably in order.

The last method is the multiplier. Here you would again look at the net profit, but you would then multiply it by some factor - it varies depending upon the industry - to get a final price. A factor of 3 would result in a $300,000 asking price. Of course, the battle is what that factor should be.

Another option is to simply hire a business appraiser. Though you will pay one a decent commission, it may be worth it to ensure that you get a fair price.