Valuation of Privately Held Businesses & Professional Practices

By – Jim Lamar, Certified Business Intermediary

 Business Evolution

One of three things will ultimately happen to any privately held business.  It will be transferred to a relative or employee; it will be sold; or, it will cease to exist.  No one wants the latter and the former two are both forms of a sale of the business in one fashion or the other.  Even if you have no intention of ever selling your business, you should know its value from a market perspective.

 Critical Asset

Unlike most people, the most valuable asset an entrepreneur is likely to own is not a private residence.  It will probably be a privately held business enterprise or professional practice.  If so, it forms the foundation of the entrepreneur’s net worth and is a critical part of any financial planning.

Sooner or later every business owner needs a reliable business valuation.  There are a number of reasons for valuing a business including:

 Or, to simply answer the question, “Is this the right time to consider selling my business?”

 Valuation Methods

There are a number of ways to value a business.  Most industry segments have general rules of thumb that are applicable to that specific industry.  If you have been in business for any length of time, you probably know the rules of thumb for your industry.  Beyond general rules of thumb such as earnings and gross revenue multiples, there are many additional approaches to valuing businesses.  Some of the valuation methods used include: comparative transactions: asset accumulation; capitalized excess earnings; capitalized earnings; and, Direct market data.

Method Selection

Which one is right for your business?  That depends.  Different approaches and concepts may be more appropriate for different valuation purposes.  Valuations performed for one purpose may not be applicable for another purpose.  The purpose may also dictate the form and content of the valuation report.  For example, valuations performed for certain purposes may need to conform to specific IRS requirements. 

Depending on the purpose for the valuation, several methods will likely be utilized and a value range established based on some combination of the results of all of the methods utilized.

Problem with Rules of Thumb 

Rules of thumb are probably sufficient for a “guesstimate” of a business’ worth.  However, they do not always work.  For example, assume both Company A and Company B has revenues of $1,500,000 and net income (earnings) of $300,000 annually.  The industry has a rule of thumb earnings multiple of 2.75.  Are they both worth about $825,000? 

Not necessarily.  Company A’s owner has a great management team and personally works in the business 20-30 hours per week, has no debt and takes six weeks of vacation per year.  Company B’s owner works 80 hours per week, has no manager that he can trust to run the business, owes over $250,000 in working capital loans, and hasn’t had a vacation in five years.  The rule of thumb in this case simply doesn’t work.

Valuation Options & Cost 

There are a number of firms in the market today offering valuations of businesses and planning summaries for $20,000 to $35,000 or more.  For most firms, there is no reason to spend that much for a good quality, professional valuation.  Acquisition Logic Group offers a variety of valuations from a no cost, free price evaluation report that can be used for setting a sales price for a business to complex business appraisals that may be used for all sorts of reasons costing several thousand dollars.  The cost of the more formal appraisal will depend on the complexity and size of the business and the condition of the financial records.  A company with annual sales less than $10 million with good quality financial information should be able to get a professional valuation using a number of tested methodologies for around $5,000.  Companies with annual sales in the $1 million range with good quality financials records can expect a cost of approximately $2,500.  Whatever you do decide, please be sure to consult with a professional business broker that has access to certified valuators.  

To learn more about a valuation for your business, click here.