When sales are strong and business is doing well, you may give little thought to retirement. When you do think about it, you may tell yourself that when you are ready to sell, you will get a good price and live comfortably off the proceeds. Perhaps. But what if you cannot get a good price for your business? Or worse: What if no one wants to buy your business?
Of the small-business owners surveyed by American Express, 60 percent said they were not on track to save the money needed for retirement, and 73 percent said they were worried about their ability to save enough to live as they want to when they retire.
If you have no plans of selling your business, you will need to replace the income you receive from your business with another income stream. Or you may intend to sell but no time soon. Whether you plan to sell in the near future, in the distant future, or not at all, I suggest running your business as if you intend to sell it. So you have to know what it is worth.
When determining the value of your business, overlook sentimental value. You may have spent years working 10-hour days (or more) to make the business successful, or your business may have helped you put your kids through college. The market does not care. Sentimental value adds zero market value. Prospective buyers or investors want to know one thing: How much can they make from your business? Since this is their primary concern, it should be yours too.
Anything that gives your business a competitive advantage also increases your business’ value. Here are some examples:
Contracts: What kinds of contracts do you have (1-year, 3-year, 10-year)? You need profitable books, of course, but contracts add value because they guarantee future revenue.
Patents: If you have patented a process, for example, your competitors cannot duplicate it.
Equipment: If your equipment is new or cutting edge, a buyer would not need to upgrade.
Name recognition: If your business’ name is recognizable and your business has a good reputation, that adds tremendous value. But your business has to have a good reputation from the consumers’ perspective. You may think your business is the best in the industry, but what counts is what consumers think.
Workforce: If your workforce is experienced and works well together, a buyer would not be burdened with attracting and hiring employees.
Your business and your home probably are your two biggest investments, so you should get in the habit of increasing the value of both. When I was younger, for example, I loved shag carpet. I thought it was cool! It was cool in the ’70s, but it’s not anymore, which is why I ripped it out and put down new carpet. I still love shag carpet. But the market does not.
There are several ways to determine your business’ value, but remember: It does not matter what it is worth to you. What matters is what it is worth to someone else.
If you need an official, professionally prepared business valuation, you will spend between $3,000 and $40,000 depending on how detailed you need it and how complex your business is. Official valuations require three weeks of probing your business’ finances, management structure and operational structure.
If you do not need an official valuation, you can calculate the value yourself. Here are some ways to do that.
Asset-based approach: How much will it cost to replace all of your assets with equipment in similar condition? If the value of your business assets is greater than your earnings, use this approach.
Market approach: You determine your business value by comparing it with comparable businesses (i.e., businesses with similar assets) in the market. Do not use this approach, however, if your business operates differently from comparable businesses.
Income approach: You determine value by looking at earnings.
1) Look at the past three years’ earnings, and calculate your three-year average.
2) If your average earnings are $100,000 or less, use a multiple of two. If between $100,000 and $500,000, use three. If average earnings are more than $500,000, use four.
3) What will your business have left after all its debt (bonds, cash, equipment, real estate, stock) is paid? Add the total value of your net liquid assets to your average earnings, from the previous step.
Most small businesses sell for two-to-three times the amount of their earnings.
If you do not need an official valuation, and you are not good at math, you have a third option: Buy an online business valuation. BizEquity, one of several online business-valuation services, charges about $365 for a 23-page report.
Whether you pay for a valuation or calculate it yourself, I urge you to find out how much your business is worth. Then continually upgrade your equipment, processes, technology, and workforce, so when you are ready to sell, someone besides you will see the value in your business.
Marvin Carolina Jr. is a vice president for JE Dunn Construction. He can be reached at email@example.com.