Valuing a Small Business For Sale

Here are various methods to consider in determining your selling price. In most cases you should use a number of them together.

By Jeffrey Clack & Peter Siegel, SCORE Counselors Chapter 411, Northeast Massachusetts

Correctly pricing your business for sale is related to many decisions,

  • will the available cash flow of the business be able to pay the debt of a loan,
  • will the deal as structured or priced be attractive to financing sources,
  • "cash" price vs. "loan" price and how these factors figure into the equation.

Here are various methods to consider in determining your selling price. In most cases you should use a number of them together.

1. Market Approach

In a strong economy your business may achieve a higher price than in a slower economy. The type of business, the number of local and national competitors, and the start-up costs for a similar business all are market factors. It comes down to what will someone pay for your business in the current market?

2. Adjusted Net Income

Adjusted net income is the total amount of cash produced by your business. It's a figure that includes the profits, the owner's salary and all of the many cash-related benefits which are enjoyed by the principals of small businesses. Those benefits can include the use of a company car, the company-paid premiums for health, life and auto insurance, plus personal expenditures tucked into travel and entertainment, subscriptions and similar business "expense" categories. Interest expense should be added to adjusted net income, along with accounting entries—such as depreciation and amortization—that can divert money to the owner's pocket so that it never appears on the bottom line of the P&L.

3. Multiplier Method

The multiplier method takes the adjusted net income and multiplies it by a factor of how attractive the business is. A low risk business is one where high market demand is reflected in a fairly strong multiple. Its multiple might be in the range of two to three times annual adjusted net income. A one or two multiple, on the other hand, would be associated with an enterprise in which the buyer is assuming greater risk. An example is a retail store near a large shopping area, which leaves the buyer of the smaller business vulnerable to the competitive marketing activities of much larger companies. More commonly available businesses, such as restaurants, are priced with a lower multiple - in the one to two range - to reflect the abundance of this kind of business available for sale at any one time. It's purely a matter of supply and demand.

4. Importance of Deal Structure/Terms

The terms of a transaction are critical in calculating a price. When sellers demand all cash for their businesses, for example, the market tells us that they can expect to receive about 60% to 80% of the sum they would have gotten by taking a down payment and financing the balance.

A deal that requires a lot of cash up front, in relation to the expected amount of adjusted cash flow, will place a greater burden on the buyer. That principle, translated into the language of the marketplace, means the business will only be appealing at a low price. If, on the other hand, the level of adjusted net income supports the buyer's ability to make payments to the seller in order to purchase the business the offered opportunity will interest more potential buyers and the result is a higher achievable sales price.

5. Existing Customers Value

The customer purchase history for your product or service is extremely valuable. The more customer information you have including contact information, purchase history, contact profile information (personal information, preferences, work history), and your sales engagement history with the account – the more valuable your customer data is related to the sale price for your business. And how concentrated are your sales by customer? Do 20% of your customers provide 80% of your income? Whatever your sales concentration is, it can be used to your marketing advantage.

6. Asset Value

All your hard assets have value. Any equipment, computers, vehicles, materials, etc. represents a value in the sale of your business. They can be valued by market value or depreciated value on your books.

In Summary

Valuing your business depends on many variables – some which you control (fixed assets, customer data) and some that you don’t (current market conditions). Do your homework utilizing all your best resources: accountant, tax advisor, lawyer, and SCORE counselors. You must assume the buyer has done their homework with their resources as well.