What's It Worth To Get The Right Valuation For Your Firm?
Boston Business Journal
By Matt Kelly
Maybe you've decided to cash out and sell your business. Congratulations. After years of hard work, you're entitled to an easier life.
Or maybe you want to get into the game for the first time and own a business yourself.
Either way, the same question confronts both camps: How do you decide what a business is worth?
Entrepreneurs misunderstand the value of a business, even their own, "all the time" says Brace Carpenter, a partner at business broker Carpenter Hawke & Co. in Boston. "People get advice all over the place."
The single most important number to consider is free-cash flow. That figure determines how much a buyer can give himself as a salary, how much he can afford in debt to buy the business and how much of a return on investment the buyer is likely to see. Combined, those three items determine a reasonable selling price.
Sam Liss, principal at The Coral Group, a business brokerage in Wellesley, gave the example of a business with $400,000 in annual free-cash flow. The seller wants $1.2 million, and a buyer is ready to put $400,000 down and carry the rest on a $800,000 loan at 7 percent interest over 5 years.
From that $400,000 cash flow, the buyer might want $100,000 for his compensation. Another $190,000 would be needed to cover interest payments on his monthly note. That leaves $110,000 per year, a return of 28 percent ($110,000 divided by his $400,000 down payment). In that hypothetical, Liss says, the $1.2 million asking price is probably fair. Less cash flow would mean a smaller return - but in a rock steady industry, the small return could be the norm. Or the business could be in a volatile sector, such as technology, where a 28 percent return is too little.
Negotiations on a final price will hinge on the buyer's appetite for risk and return. "The best transactions happen when everyone understands the numbers," Liss says.
Executives can get a sense of a company's value based on its industry, Carpenter says. Restaurants routinely sell for 25 percent to 40 percent of gross sales; hotels and motels sell for six to ten times free-cash flow.
"You can't put a stamp and warranty on those numbers and go to court with them.....but they are good guides," Carpenter says.
Determination of a company's exact value almost always involves an outside expert: a lawyer, business broker or professional business evaluator. Brokers such as Carpenter and Liss act as matchmakers for the small-business world, finding buyers for would-be sellers or visa-versa. They can be vital players in the process, since they can assuage buyers on the value of a business - and, ultimately, the buyer's enthusiasm determines what he is willing to pay.
Selecting a business broker is much like hiring an accountant, publicist or any other service professional: get recommendations if possible, ask for references and consider how well you relate to the person both personally and professionally. Most reputable brokers can be found in the phone book or on various Internet listings.
Enterepreneurs should also expect some grilling themselves. Brokers succeed based on their reputation, and no broker wants to represent a dubious client trying to unload a lemon of a business. "It goes without saying that you want to know why someone is selling a business," says Michael Gilboy, partner at Spencer Brook Partners in Concord.
Once a possible buyer emerges, brokers help sellers through due diligence. That proces isn't always easy, Gilboy say, especially if business owners have a system of record-keeping that might be difficult for others to decipher. The broker's job, he says, is to "find ways to get answers to the questions buyers have."