Most small business owners have unrealistic ideas of how much their business is worth. Part of the confusion is caused by what people read in the news. The sale of big companies reported on the news and the valuations they achieve have very little to do with the business valuation of small, privately-held businesses. Here are 6 facts on business valuations that surprise most small business owners.
1. Small businesses usually don't sell for a multiple of revenue. The buyers of small businesses are often individuals who are getting into business for themselves. In other words, they need to make sure the business generates enough profits to pay their bills. As a result, the profits of the business matter a lot more to the business valuation than the revenues do.
2. Future growth potential doesn't increase the value of the business that much. Unfortunately, the buyers of small businesses place an emphasis on the proof of profits. While the buyers of larger companies may make a strategic purchase and pay millions or even billions for a company that has not proved itself profitable, the buyers of small businesses primarily base what they are willing to pay on the profitability history of the business.
3. The business value doesn't go up just because it's been established for a long time. Unlike real estate that typically experience appreciation over the long run, the value of a business doesn't necessarily increase due to a long operating history. Having too short of a history can hurt the value of the business, but a company that has been in business for 50 years is not automatically more valuable than one that has been in business for 10 years.
4. The most recent year's performance trumps the historical performance. If a company was profitable for many years but experienced a bad year last year, the value of the business would be dramatically hurt. Conversely, a company that performed poorly for many years but experienced a great year last year would see an increase in the company value.
5. The buyers don't pay extra for equipment. From the buyers' perspective, the company equipment is just stuff one needs to run the business. Having a lot of expensive equipment does not increase the business valuation, and all the equipment is typically included in the sale price of the business. If a manufacturing company has $1 million worth of equipment but a business valuation of $400,000, the owner is typically advised to sell off the equipment rather than selling the business along with the equipment.
6. It takes time to translate a business valuation figure on paper into cash at the bank. The national average to sell a business is 6 to 12 months. Having realistic expectations will help small business owners obtain and achieve the company valuation they are looking for.
Texas Economic News
