Valuing A Small Business

As the old saying goes, three things drive value in real estate: location, location, location.  While that saying can provide an inkling of the value of the real estate your business owns, what drives the value of the business itself?

Small Business Valuation Drivers

Regardless of who you look to for statistics, the fact of the matter is small business is the heart of the American economy.  Consider numbers like small business:

  • Represents more than 99.7% of all employers
  • Create about ¾ of the net new jobs in the US
  • Employ almost 62% of the workforce
  • And account for more the 60% of the gross domestic product of the US.

Despite these impressive statistics, the valuation of small businesses isn’t a science.  Buyers and investors will look at an opportunity through the glasses that represent their experience with similar businesses.  If they’ve been successful with or know someone who was successful with a similar business in the past, valuations will be more favorable.  If they’re unfamiliar with the business, valuations will reflect their perceived increased ‘risk”.  But how will the value of your business determined?

    • Consistent Performance – as you’ve found in running your business, consistency is nice.  You know what kind of income to expect, your employees have the comfort of job stability, your bank is asking if you’d like to borrow more money, etc.  Of course, a certain amount of inconsistent performance can be explained.  Perhaps your business is cyclical – as long as the cycles are consistent over a period of time, fine.  Perhaps your business is tied to larger market trends – okay, but you’re better off if you can describe how you can insulate your business from the lowest lows while taking advantage of the highest highs.
    • Business Strategy, Financial Controls and Systems – your business plan will show investors what your overall strategy is compared to your market and competitors.  Financial budgeting and monitoring actual results compared to budget in a timely manner provide buyers and investors with comfort that the business is under control – especially in times of changing markets or economics.  Financial projections are a critical adjunct to your business plan.  They show you’ve thought about all aspects of the company’s growth and can spot trends that are keeping you from growing.  And, as the trite saying goes, having systems in place that provide this type of information in any level of detail at any time – priceless.
    • Management Team – is critical to the long term success of any business.  Having a management team with a seasoned professionalism makes investors feel comfortable the business is truly sustainable beyond the owner / entrepreneur’s involvement.
    • Defensible or Sustainable Markets – if you have a unique product or service great.  If you have a patent or other defensible legal position, even better.  If you have operational, financial and sales processes that effectively keep competition at bay . . . congratulations.  You have a valuable business.  The trick of course, is convincing a willing buyer this is the case.

What You’re Looking For

Valuations can also depend on what you’re looking for.  For example the outright sale of your company may drive a different valuation than an equity infusion to continue a growth trend or to enter new markets.  Typically, investors like to see the original owners continue with a stake in the business.  Someone who wants to cash out completely may get a different valuation than someone looking for a ‘second bite at the apple’.

What can you do to control the Valuation?

Clearly, given the valuation drivers, there is significant work that can be done to prepare your company for this ultimate event.  Update your business plan and overall business strategy.  Make sure your management team is well rounded in all disciplines and make sure they’re given the authority and responsibilities to make decisions after being given direction from the Leader (you!).  Lastly, think about what makes your company unique to the needs of your customers – what satisfies their need to feel their investment in you and your employees is a valuable one.