Entrepreneurs can maximize the worth of their businesses by understanding
how dollar values are calculated, says Frederick D. Lipman, a Philadelphia
attorney and author of How Much Is Your Business Worth?(Prima Publishing).
"You want to understand what the components of value are and try to
develop those components to maximize the sale price," he says, adding that
small-business owners should complete a valuation at least five years before
they consider selling so they have time to address weak spots.
Lipman says that the EBITDA (earnings before interest, taxes, depreciation,
and amortization) method is probably the most common, assuming
a company has earnings. And small ventures tend to be measured
on "comparable prices" or "rule of thumb." However, he says, many experts calculate
a company's value using several different formulas and average the results.
"It's not a science. It comes down to what a buyer is willing to pay,"
he notes.
Here's a summary of some of the more common methods used to determine
the value of a business:
- Rule-of-thumb formulas. In various industries, businesses worth
less than $5 million are valued using rule-of-thumb formulas. For example,
insurance agencies typically sell for one to two times their gross annual commissions,
while restaurants sell for 0.3 to 0.5 times their gross annual sales.
- Earnings. Businesses worth more than $5 million are generally
valued on the basis of EBITDA. The EBITDA is then multiplied by a relevant
multiplier to get a valuation. Lipman says a typical multiplier for businesses
of this size ranges is four to six times EBITDA. However, that varies depending
on the industry and market.
- Net Asset Value. Calculated by adding the values all of
the business' assets and then subtracting liabilities.
- Comparable prices. Based on prices for similar businesses
that have recently been sold.
- Stock market. Based on the per-share price for comparable businesses
that are public companies.
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