What Is Your Business Worth? Understanding the Value of Your Business

Business owners often develop a “value” for their business based on outside transactional data. The transactional data could come from published summarized data, such as DealStats Quarterly Value Index, or be based on what they “heard another business sold for.” They apply a multiple of revenue, EBITDA, or other benchmark based on this data to their business and… PRESTO! They know what their business is worth! This can be a misguided belief, though. Without specific knowledge of the facts, circumstances, and timing of the transaction, as well as the motivation of BOTH the buyer and seller, one will not have a true picture of value.

What Impacts Business Value?

Asking and answering the 5 Ws from elementary English class (Who, What, Where, When, and Why) and then considering one additional item, Terms, can help one get a fuller picture of value. First, let’s look at each of the five questions to see how they can impact the value of a business.

Who?

Who is the seller and who is the purchaser? Did the seller have financial motivation to sell (e.g., divorce, personal need for cash)? Did the purchaser have a motivation outside an investment in the business? Did they want to purchase a direct competitor and its market share? Did they have a strategic reason to purchase the business, such as excess capacity or to gain a foothold in a new geographic market? Were they simply looking to purchase a job? These answers will impact value.

What?

What was sold? Was it a sale of the company’s stock or was it a sale of their assets? If it was a sale of stock, was the entire ownership interest sold or was it a minority interest in the business? Was there debt on the books that would reduce the price an investor would pay for the stock? If it was an asset sale, which assets were sold? Were all of the assets sold? Were liabilities assumed by the new owner and if so, which ones? These answers will impact value.

Where?

The location of a business and the market served can impact its value. Some geographic locations are more economically depressed than others. All other things being equal, a reasonable price for a business in one part of the country may not be reasonable in another due to the different locations.

When?

When did the transaction take place? Was the economic environment different when the transaction took place? Did the transaction contemplate an economic event that has now happened? Could “multiples” from the transaction be stale due to the passage of time or changed circumstances such as new tax laws? These answers will impact value.

Why?

This is one of the most important questions to know the answer to. A few “whys” were already discussed; a need for cash, the elimination of a competitor, a gain of market share. Other reasons could be the purchase of a critical piece of technology, a gain of niche expertise, or the purchase of a complimentary product or service. The owner may have had health concerns and needed to sell the business quickly, resulting in a lower price. The “whys” could be endless, but the answer can result in a purchase price that is greater or lower for a particular business when compared to another.

Terms

In addition to the 5 Ws, there is an additional factor that can have a dramatic impact on the agreed upon price of a business – the Terms of the deal. Terms that are different than those typically found in the market can result in a higher purchase price which still makes sense for the buyer. An example would be 100% financing through a seller note with an extended term at the annual long-term Applicable Federal Rate (AFR) of 4.55% at December 31, 2025. The resulting transaction price could be substantially higher than one with current market rate terms.

The answers to the 5 Ws and the Terms associated with a transaction can have a significant impact on value. Applying transactional information from the sale of one business and applying it to another is a dangerous practice at best without knowing the specific facts and circumstances.

Understanding Current and Future Value

A qualified, experienced business valuator can help a business owner understand what drives the value of their business not only today, but also in the future. They can educate owners about the different standards of value (fair market value, investment value, and others), the approaches to value (the market approach, the asset approach, and the income approach), and what the correct methodology under each of these approaches would be given the specific facts and circumstances of their business, the current economic environment, and the reason for the business valuation.

At McKonly & Asbury, our Business Valuation team has extensive experience within the valuation industry. Should you have any questions, please contact T. Eric Blocher CPA, ASA, CVA.

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