In my experience, when speaking with many small business owners one theme is more prevalent than any other and this is how much they think their business is worth. We have all heard or read in the news about blockbuster sales of a large or public companies selling for millions or billions even though they don’t make any money. The valuations these companies receive have nothing to do with business valuations of small, or even medium size privately owned businesses.
5 Business valuation facts that may shock you.
1. Small businesses usually don't sell for a multiple of their revenues.
The buyers of small businesses are often times individuals who are getting into business for themselves or investors that want to take a hands on approach. These buyers need to make sure the business generates enough profits to pay their bills and pay their salaries plus provide a sufficient return on their investment. Profits are king and matter a lot more than revenues.
2. The most recent year's performance is most important.
The emphasis is on the last year’s performance, and usually a simple average or a weighted average of last 3-5 years is considered relevant to establish revenue and profitability trends. Value will be increased or decreased by a larger proportion based on last year’s numbers.
3. Future growth potential doesn't increase the value of the business but may make it more marketable.
Proof of profits and consistent cash flows is what buyers will pay for and not future potential. Buyers of larger companies or public companies may purchase and pay millions or even billions for a company that have yet to make a profit and usually do so for strategic reasons and in many cases, pay with non-cash considerations such as shares or earn-out arrangements. Small business buyers primarily base what they are willing to pay, on the profitable history of the business.
4. The buyers don't pay extra for assets or equipment.
From the buyers' perspective, the company assets, equipment, working capital is just stuff that is needed to generate the cash flows and to run the business. All these assets are typically included in the price paid for the business. In cases where equipment is worth more than the business itself, the vendor is better off liquidating the equipment and winding down the company rather than selling the business as a going concern.
5. It takes more time to sell a business than you think.
The North American average time to sell a business is 9 to 12 months. The larger the business, the higher the business value, the longer it takes to sell and go through the due diligence phase. Expect that it will take a year or longer to sell your business, it will take up more of your time than you think to receive a realistic value for your business.
Ensure you are positioning the company for sale and develop realistic expectations of the company’s value. The best place to start is to obtain an independent professional business valuation to help you set those expectations correctly.
Malahat Valuation Group