Question: I get solicitations from business valuation firms. What’s so important about business valuations? Do I actually need to get one if I’m not planning to sell anytime soon?
Answer: There are a number of valid reasons to get a professional business valuation. And really, assuming your small business is your family’s biggest asset—perhaps other than your home—isn’t it smart to have a realistic idea of what it’s worth? Recent research shows many small business owners are counting on their companies as nest eggs—they’re less likely to have diversified investments because they plan to retire on the proceeds of selling the business.
That said, you should probably ignore those solicitations. “Fishing for work by valuation firms when there is no real need is both unprofessional and a waste of client resources, money, time, and efforts,” Jack Bakken, past president of the American Society of Appraisers, writes in an e-mail.
When would a valuation be needed, other than for a sale? “Most commonly they are done for tax purposes, such as estate settlement, income tax or property tax disputes, or litigation, or to satisfy the annual requirements for Employee Stock Ownership Plans,” he writes. Other situations that could require a valuation include mergers and acquisitions, bankruptcy, estate planning, gifting of minority stock interests, qualifying for a loan, or taking on an investor.
Rick Gould, managing partner at New York City mergers-and-acquisitions company SGP Worldwide, specializes in valuations of creative services companies. He says a typical valuation takes about three weeks and requires substantial probing of the company’s financial documents, management, and operational structure.
Valuations in the U.S. cost between $3,000 and $40,000, depending on the accuracy needed and the complexity of the company involved, according to a February report from independent research firm IBISWorld. Preliminary valuations—which turn out at least a rough number—usually cost $3,000 to $10,000, the report says.
That’s a lot of money for many small companies. The process of pulling together the required financial documents can be time-consuming, and the results can be painful if they don’t live up to expectations. It’s no wonder that “many business owners have absolutely no idea—or the wrong idea—about what their company is worth,” according to Julie Gordon White, principal at BlueKey Business Brokerage Mergers & Acquisitions.
She recommends that entrepreneurs get at least a ballpark estimate of their company’s value on an annual basis, though they don’t have to pay for a certified appraisal. Just having a reliable figure in mind “does wonderful things, like make you more realistic about how you’re spending your money and how that’s affecting profitability, and it helps you make plans for the future,” she says. “Having a number also relates to how you value yourself as an entrepreneur. Are you growing something that just makes money along the way but can’t be transferred to someone else eventually? Or can you make changes so it is profitable enough so that you’ll sell it someday and get that pot of gold that could fund your retirement?”
For do-it-yourselfers, Gordon White recommends a basic calculation. Figure your business’s discretionary earnings for the past three years: That’s net profit plus owner’s salary and benefits (health insurance or a company car, perhaps) added to interest, amortization, and depreciation—all figures you should be able to find on your tax returns. Next, average that number over the three years. If the result is $100,000 or less, multiply it by two; if it’s $100,000 to $300,000, multiply it by three; if it’s over $500,000, multiply by four.
“The conventional wisdom says that most small businesses sell for between two to three times’ discretionary earnings. That fits my experience over the past 10 years,” she says, though there are some exceptions, notably technology companies that hold intellectual-property rights.
If you want to get a more detailed figure, but don’t want to pay for a formal valuation, there are online alternatives. Michael Carter, founder and chief executive of BizEquity, says his website charges $365 for a 23-page business valuation report based on financial information you enter yourself. “Like TurboTax, it gives you your value as you go and it’s free up to the end, so even if you don’t opt to buy the report, you can do a few steps and get some idea what your company is worth,” he says.
In an era where finding a home’s estimated value is as easy as typing in an address, “it’s crazy that we have 28 million small businesses in this country and a majority of them probably don’t know what they’re worth,” Carter says.