The Secret to Valuing a Small Business

You have worked hard to build up your business over 20- to 30-years, in order to leave it to your children (who it turns out don’t want it) or to sell it to finance your retirement.  So you value it at what you think it’s worth, including all of your “sweat equity” (I hate that term). Almost every business sale includes a value by the seller which is much higher than the actual value of the physical assets of the business.  If you are the buyer, how do  you know you are not paying too much for the business?

The Secret: The value for a business is the amount agreed to by a willing buyer and a willing seller, for which both parties are  mutually uncomfortable.  I love this definition!  My husband created the “mutually uncomfortable” thing, and I agree.  It means neither party thinks he/she got “taken,” and neither party thinks he “stole” the thing.  Both parties feel a little uncomfortable (I think I sold my business for just a little too little; he thinks he bought it for a little too much.) In other words, the value of a business is what the parties think it is.

Valuation Drivers. A recent Forbes article discussed the valuation of a flower shop and mentioned the key valuation drivers:

Location and Facilities: For local businesses, a location that draws customers and facilities that look fresh and inviting are important.  Not so much for online businesses, although you could call the look of a web site “location.”

Reputation: Otherwise known as “goodwill,” reputation is the key driver of valuation.  Goodwill can be measured in some businesses which have a continuing clientele, but it is difficult to measure goodwill in a flower shop or other retail business that has no way to track repeat customers.  One possibility is to check customer reviews on  Yelp.com.or other online rating site.

The true value of a business depends on the skill of the negotiators and the willingness of both parties to see the deal through to completion.  Sure there are some “rules of thumb” for such things, but each situation is different. For more information, see my About.com article on Valuing Your Business for Sale or get a copy of Business Valuation for Dummies.

Image: popaver@flickr