You are getting ready to sell your business so you must ask yourself some questions: When do I want to exit? Who are the most likely buyers? Is my business adequately prepared to sell? How does it compare to other like businesses? And of course, what’s my business worth?
All business valuation relies on some prediction of the future. Business appraisers apply a variety of adjustments to financial statements, theoretical constructs and historical data to divine the future. Numerous valuation approaches and methods are used, but the most common valuation formula is quite simple:
Value = Expected Cash Flow / Risk Adjusted Expected Return
Private equity firms often bypass valuation theory and use their judgment to apply a multiple on adjusted EBITDA (a common but incomplete proxy for cash flow) after scrubbing the financials and gaining a basic understanding of the business.
Likewise, buy-sell agreements often call for a specific price formulas. The advantage in this method is that it’s easy to understand and appears to be a cost-effective way to value a business.
Simplicity is a good thing, except when it conceals or misses important information. For example, let’s say your industry has businesses that have sold between 3-6x EBITDA. How can you understand where your company deserves to be within that range? Not knowing can be costly — either in terms of not getting a deal done because you held out for 8x EBITDA, or because you sold for 3x, when you could have received 5 or 6x. Improper valuation can easily result in hundreds of thousands or millions of dollars of lost opportunity.
A buyer seeks a reasonable return on their investment, without excess risk. Your task as a seller is to persuade buyers that the cash flow they see will adequately compensate them for the risk of the business. Without a clear understanding the various cash flow adjustments and factors that determine risk, and how that translates to market value, you enter the negotiation unprepared.
A business valuation performed by an experienced professional makes good and common sense. It will help you make better decisions when considering your various exit options.