As a Chartered Business Valuator (CBV), almost every business owner I meet wants to know the answer to this question: “How much is my business worth?”
There can be many reasons for asking this question: they may be planning to sell the business; they may be in litigation with another shareholder; they may be considering tax planning strategies; they may be getting expropriated by a government authority as part of a construction project; or they may be getting divorced.
Inevitably, my response to the question of “how much is my business worth” is to turn around and ask the business owner some questions of my own. These include:
How much does the business earn?
This is a deceptively simple question. Unfortunately, it is not enough to look at last year’s financial statement; what I am interested in is the true economic profit of the business. This means adjusting the reported revenues and expenses to reflect how the results would look if the business were run by someone else. Thus:
- Did the owner(s) receive a fair market salary for their services? If your business reported $50,000 in profits last year, but you, your husband and your children all worked there full-time without drawing a salary, how profitable was it really?
- Were there any personal or discretionary expenses reported as business expenses? Common examples are meals and entertainment and automobile expenses. Such costs are often not necessary for the operation of the business and should be added back in estimating economic profit.
- Is all revenue reported? Some businesses may appear relatively unprofitable, but may still have significant value once historically unreported sales are considered.
- Are there other non-arm’s length transactions? For example, if the business operated out of a building you own and paid below-market rent, the rent expense will need to be adjusted to market rates.
Are there plans to grow? And what will those involve?
Two businesses that earned identical profits last year may attract wildly different valuations depending on their potential growth prospects, so it is important to understand whether significant growth is expected. But growth comes at a cost: there are often significant upfront capital and operating costs that must be incurred in order to achieve growth, and these must be considered.
Does the business have any assets it can sell off without any impact to its results?
Revenues and expenses are only one part of a business valuation. We always look at the balance sheet to see whether there are assets that can be spun off without impacting operations; if so, then the value of these assets is added to the overall valuation.
So how much is your business worth? Give some thought to these questions – and then call me.
By Ephraim Stulberg.