WHAT IS A BUSINESS WORTH?

The fair market value of a business is defined as the cash or cash equivalent at which a business would change hands between a willing reasonable Buyer and a willing reasonable Seller in a reasonable amount of time. This assumes that neither the Buyer nor the Seller is under any compulsion (irrational motive) to buy or sell and both have a reasonable knowledge of the relevant facts. It is when the motive to sell is the same as the motivation to buy for the same price.

To assist in determining the fair market value, a Business Valuation should be prepared. A Business Valuation is an estimate of business’ value, the suggested sales price, based on standard formulas and historical information of similar businesses. A business Valuation will help to reinforce the asking price and allow the Seller to better understand how a potential Buyer may look at the business.

A business valuation should not be confused with a business appraisal. A Business Appraisal generally refers to an in-depth, detail report that complies with the provisions as set forth by the Uniform Standards of Professional Appraisal Practices. An appraisal company generally uses several approaches in determining the value such as, the Discounted Future Earnings Method, Capitalization of Normalized Earnings Method, Private Transaction Comparable Method, Publicly Traded Multiples as well as other approaches.

Regardless what valuation approach is used, for a privately held small businesses valued less than $500,000 (which comprises about 90% of all the businesses), a reasonable selling price for the business can usually be determined by adding the asset value of the business to a multiple of the owner’s annual cash benefit including the value of the perks. The multiplier generally ranges from six months to two or three years of financial benefits.

Larger businesses with more predictable future earnings, especially if they have a strong position in the industry may be able to use a multiplier of four and even five years of financial benefits. Those businesses tend to have more of its own identity which perpetuates the business as opposed to being driven primarily by the owner/operator. This multiplier is influenced by the value assigned to the various items listed in the ‘Elements of an Established Business’.

How Much Can A Buyer Pay For A Business?

After a fair market value is calculated, in the final analysis, for a Buyer to purchase a business for the purpose of being the owner and operator, the business must be priced at an amount that when the revenue generated from the operation of the business, allows the Buyer to, at a minimum:

What Will a Lender Loan?

After all the business elements are determined to be acceptable, such as the assets, business history, cash flow, reasonable anticipation of future business and the buyer’s credit and ability, the lender will want the cash flow of the business to be between 1.3 to 1.5 the total debt service on the business.