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What’s Your Business Worth?
Can you sell it and retire someday?
by Chuck Dushek
Capital
Management Associates
801 Warrenville Road, Suite 195
Lisle, Il 60532
Voice: (630) 963-4235
Fax: (630) 963-4236
chuckdushek@cmaadvisors.com
Business valuation is complex, but certain elemental principles apply. A prospective buyer is purchasing a “future cash stream” from the current owner along with the assets needed to produce those earnings. Future business expectations will depend heavily on the firm’s last 3-5 year growth rate on earnings and sales. Those anticipated future earnings are usually discounted to what’s called “a net present value” based upon the perceived risks of the business going forward. Therefore, the keys to valuation maximization are having attained a strong earnings growth rate and a minimization of risk in the market that you operate in.
In summary, the business valuation optimizers are: a growing broad and diverse customer base, an expanding operating margin year-on-year, annuity streams of income from recurrent sales, growth in transaction size and frequency per customer, all achievable within small and midsize businesses.
Drilling down further in the business’s financials, the owner’s income received is completely deleted and replaced with an estimated cost to replace the owner/ operator with a manager at a market rate of pay. All non-essential business cost/ expense perks sustained by the owner are adjusted out of the business expense accounts. This leaves the annual earnings amounts clean to give the most accurate representation of the business’s true operating income. Income tax expense and interest expense are also eliminated from the picture, because each individual owner can have their own unique tax treatment with flow-through sub-chapter S corps and LLCs being so prevalent. Further, interest expense in a company is a preference by the owner as to how much capital one wishes to use to run the business as “permanent equity” or “via the use of borrowed money” to create favorable financial leverage.
On the math side to get a handle on potential business value, this formula is used: Net Present Value = Current Earnings/Capitalization Rate (Discount Rate minus the Long Term Growth Rate). The discount rate or multiplier of earnings for a typical small to mid-size business is around 25% or 4 times. If the historical earnings growth rate has been 5% per year, the denominator (Capitalization Rate) is (25%-5%) 20%. When taking the 20% into 100% we get a 5 times multiple on earnings. If the earnings were $400,000, then the value of the firm is $2,000,000. If a firm had no or nil growth on earnings over the past 3-5 years, the firm’s value would be less, and probably not very attractive to the average business buyer seeking a firm with growth potential.
What can you as an owner do? There are a host of manageable steps an owner can take to address valuation issues. Customer and supplier concentrations are always an area of negative concern. Size matters here too.
A small business has little depth compared to a larger one with greater scale for productivity potentials. Get a business valuation from an accredited appraiser and review the report carefully with them to see how you can better manage your company for maximum future value.
Contact Paul or Lynn for more information or to discuss a project.
Zuk-Lloyd
Associates, Inc.
30W261 Holyoke Court
Warrenville, IL 60555
630-393-6516
Visit our other web site, PromiseGarden.com, a rest stop on the information superhighway
Paul is available as a motivational speaker covering marketing communications and general business topics. He is also available as an inspirational Christian speaker. Call for details.
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