Valuation is obviously a key issue for entrepreneurs seeking to exit a business. Establishing a fair value for a company isn’t easy, but the sale price you come up with will be an important focal point of your transition plan.
Many entrepreneurs have an unrealistic idea of how much their company is worth. That’s not surprising, since research shows that people almost invariably attach a higher value to things they own than to things that aren’t theirs, according to an article in the Harvard Business Review.
Differing expectations can cause conflict
This means you may have a different value in mind than your family successors, potential buyers, financial partners or tax assessors. That can cause conflict and affect your retirement plans.
Even if you’re giving the company to a family member, you may require an objective valuation to ease family disputes, plan your estate and optimize your tax treatment.
Because of the complexity and stakes, it’s helpful to hire a professional valuator to help you set a selling price and determine whether a buyer’s offer is reasonable. A tax expert can also tell you how the various valuation options impact your tax liability in a sale.
An outside evaluation will hold more sway with potential buyers than numbers generated in house. The process may also help you identify weaknesses in your organization and find ways to maximize its value.
Earnings are key to valuation
The most common method used to determine a fair sale price for a business is calculating a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization), which is a measure of a company’s ability to generate operating earnings.
The multiples vary by industry and could be in the range of three to six times EBITDA for a small to medium‑sized business, depending on market conditions, says Catherine Tremblay, a board member at the Canadian Institute of Chartered Business Valuators.
Many other factors can influence which multiple is used, including goodwill, intellectual property and the company’s location, Tremblay says.
After arriving at the EBITDA‑based figure, a valuator typically seeks to confirm it by applying other valuation approaches—first, calculating the value of the company’s tangible and intangible assets and, second, checking what comparable businesses sold for, says Tremblay, who is also a Montreal-based partner and National Leader of Valuations at accounting firm MNP.
If the three valuation approaches yield different numbers, the valuator investigates why and may adjust the EBITDA multiple, if appropriate. “A lot of judgement and estimates are involved,” Tremblay says. “It’s part science, part art.”
Assets may be attractive
Your business may also be more valuable in pieces than as a whole. For example, a buyer may find your real estate holdings more attractive as an asset than the entire business.
Finally, keep in mind that the price you get for your company may differ from the appraised market value and can be affected by unexpected factors. For example, a company may be willing to pay a premium for your business because it’s a good fit.