One of the most critical steps in preparing for a successful sale is selecting an appropriate asking price. To do so, Sunbelt of San Francisco typically recommends conducting a formal business valuation to estimate what your business is worth.
Business valuations and appraisals are rendered by certified and accredited professionals. Because they are disassociated with the mechanics of a transaction and charge an up-front fee for their services, they remain objective.
Our office maintains relationships with national business valuation firms to provide the best service to clients who need or desire it. Your dedicated Sunbelt business broker will advise you on the different types of valuation services in San Francisco, associated costs, and the necessity of such reports.
In some cases, a Broker Opinion of Value (BOV) is enough to select an asking price. Ultimately, the right approach will depend on the size and complexity of the business, the type of business, and the intended buyers of the business (i.e. individual investor vs. synergistic buyer).
What Determines Value?
While there are many areas that a business appraiser will evaluate, cash flow and risk are the two critical factors.
Fundamentally, a buyer purchases a business for income. Cash flow can be expressed in many ways, typically either as Earning Before Interest, Taxes, Depreciation, and Amortization (EBITDA) or Seller’s Discretionary Earnings (SDE). SDE or EBITDA is the most common basis for establishing a selling price in small business transactions. The bottom line is that the more cash flow there is, the more a buyer will likely pay to get it.
All cash flow comes with a degree of risk. Risk may be present in customer concentration, reliance on vendor relationships, macroeconomic trends, competitive forces, key employees, legal exposures, and more. A formal business valuation will include an analysis of the company’s risk and quantify that risk into a percentage known as a Discount Rate or Capitalization Rate.
Standards of Value
Value is not a singular, universal term when it comes to determining the value of a business. There are at least four common standards of ‘value’ you will hear referenced:
Fair Value (Special Value): The price at which a property will change hands between a willing buyer and a willing seller considering the specific advantages or disadvantages each party will realize (aka synergistic buyer).
Investment Value (Going Concern Value): The price at which a property will change hands between a willing buyer and a willing seller considering the investment objectives of the identified buyer (aka financial buyer).
Liquidation Value: The price at which a property will change hands between a willing buyer and a compelled seller when the property cannot be exposed to the open market for a sufficient period of time (aka orderly or forced sale).
Fair Market Value: The price at which a property will change hands between a willing buyer and a willing seller when both parties have reasonable knowledge of the facts and neither is compelled to act.
Due to its objectivity and excluding bankruptcy scenarios, Fair Market Value (FMV) is commonly viewed as the most relevant standard of value when evaluating a business for acquisition purposes. However, other standards of value may be included in the overall analysis.
What About Goodwill?
Goodwill is not a random figure – it is calculated by subtracting tangible value from the total value. The residual is considered goodwill or intangible value. Business sellers often overestimate the value of goodwill, assuming that things such as technology and an established brand add “goodwill” value that should be featured into the asking price – it doesn’t unless those items improve cash flow.
How much is your business worth?
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