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How Much Is Your Business Worth?

You wouldn’t buy a stock if you could not regularly check its value, but do you know the value of your largest investment — your business? You might think “my friend’s business sold for X times EBITDA (earnings before interest, taxes, depreciation, and amortization), so mine must be worth a little more than X times EBITDA." But without knowing the details — how the sale price was paid, expected growth in revenues, profit margins, and how much salary your friend took, to name just a few — you do not know whether the same multiple can be applied to your business. Rules of thumb, such as EBITDA and revenue multiples, can give inaccurate estimates of the value of your business, which can lead to bad decisions and missed opportunities.

Other business owners assume their balance sheet shows the value of their business. However, the value of most businesses is different from the balance sheet amounts, which are based on historical amounts, not current values. For example, some of your equipment may be fully depreciated and show zero value on the balance sheet. Intangible values, such as goodwill and customer relationships, are likely not on your balance sheet. If a buyer approached you today, would you sell for the amount of equity shown on your balance sheet.

The value of a business is based on the cash flows that business can be expected to generate. To understand — and increase — value, you must understand what drives cash flow and what makes your business unique.

Accurately valuing a business involves answering questions about the company and its operations. Here are some examples of areas to explore.

What makes your customers buy?
Are your customers buying for reasons beyond dollars and cents? Could you command a higher price by repackaging and repositioning your products with an emphasis on quality or safety, for example? A company might have a reputation for leading-edge technology, or its customers might buy because of a product's reliability or a vendor’s strong reputation for customer service.

What is the value of the company’s intellectual property?
Assets such as software-development costs, patents, and trademarks may appear on the balance sheet at a cost that does not reflect true value. Other assets, such as customer lists, supply agreements, a highly trained workforce, or a reputation for quality and service, probably do not appear on the balance sheet at all.

What is the true cash flow?
Is your nonworking spouse, who doesn’t know what your company manufactures, driving a $100,000 Mercedes paid for by the company? Are family members on the payroll being paid market-rate salaries, or is the owner receiving $1 million a year to run a company doing $20 million in sales and breaking even? Are there excessive perks? Asking these questions can reveal a more accurate picture of the company’s cash flow and, therefore, its value.

Is a solid management team in place?
Having a solid non-ownership management team in place can be a huge boost to value. A buyer is concerned with his ability to generate cash flow after he has purchased your business. If the business is too heavily dependent on you, the business will have less value to a buyer.

How well is the company managed?
Is the company utilizing its assets to its greatest advantage? Compare a variety of factors to those of other companies in the same industry, such as sales per dollar of fixed assets or employee, gross margin, and working capital turnover. If the business has a unique product or process, is it properly utilized or could it be more fully exploited?

Are there opportunities to improve the top line?
Are appropriate resources devoted to sales and marketing, or are the salespeople simply order takers? Are there opportunities to extend existing product lines or to tap new markets? Opportunities for sales growth can have a huge impact on the value of the business.

How can operations be improved?
How much can cash flow be improved by streamlining operations and cutting unnecessary costs? Are there nonessential assets that can be liquidated? Even a great sales force won’t help if management doesn’t run an efficient operation.

What are the company’s hidden assets?
Does your business have information that other companies want, such as market intelligence or customer lists? Does your company have assets that would be difficult, risky, or time-consuming for someone else to duplicate?

One company, over the course of 15 years, had developed an extensive database of market intelligence on the buying habits of Fortune 1000 companies for office products. A large, publicly traded company was willing to purchase this company to get the database, since the larger company knew it could spend millions of dollars and many years trying to gather the same information — and might not succeed.

Who might be interested in buying?
There are more potential buyers than might be first apparent. Each buyer has different needs, goals, and perceptions of value. For example, buyers for an auto parts manufacturer might include:

• Competitors looking to expand product lines
• Suppliers or customers wanting to integrate their supply chain
• Private equity firms looking for investments
• A company wanting to gain access to a particular customer
• Buyers interested in the firm’s location
• Companies wanting a recognized name

Understanding who the buyers are and what is important to them is key to understanding the value of your business.

An accurate valuation depends on seeing the full picture
Your business is probably your most valuable asset — and you are probably counting on that value for your retirement. Managing that value begins with understanding the value of your business. However, there is a lot more to valuing a business than the numbers on the financial statement. To understand the value of a business, ask questions and dig for answers, and consider getting assistance from a professional who specializes in business valuation. The payoff is a solid understanding of value — and the information necessary to make the right decisions for your future.

Questions about valuing a business? Contact Patrick F. McNally, Partner in Charge of Corporate Finance Consulting, Blackman Kallick. Pat can be reached at 312-980-2934 or pmcnally@BlackmanKallick.com.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.