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How to Sell Your Business
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Article 2: How Much Is Your Business Worth?
You’ve heard the saying, “Cash flow is king.” It also applies to selling a business.
When it comes to putting a price tag on your concern, the first thing people look at is how much cash your business generates. To figure out that number they start by writing down your annual earnings before taxes. Then they add back whatever you’ve deducted over the year for interest and depreciation. The resulting number is your cash flow.
“In general, businesses are valued in terms of multiples of cash flow,” advises Rick Rickertsen, managing partner of Pine Creek Partners, a private equity firm based in Washington, D.C. “For smaller companies, the sales price almost always comes out around the four-to-six times cash flow range. For larger companies which are perceived as less fragile, the figure might be seven or eight times cash flow.”
For example, a business with a cash flow of $1 million, valued at 3.5 times cash flow, is worth $3.5 million.
Maybe the concept of cash flow is understandable. But how can buyers decide on a multiple when assessing your business?
One common way is to look at recent sales of businesses similar to yours, notes Dr. William Rupp, dean of the college of business at the University of Montevallo in Montevallo, Ala. Such sales can be found in the 30,000-record database of the Institute of Business Appraisers.
“Maybe you start out wanting to get four times cash flow,” says Rupp. “But businesses similar to yours have recently sold for 2.5 to 3 times cash flow. So the buyer talks you down to 3.5.”
The starting multiple will be adjusted for a number of factors. Here are some examples:
How attractive is your industry? A high-growth industry will have a higher multiple than a stagnant one. How strong is the economy of the region in which you are doing business? A robust local market will put some upward pressure on your multiple. How dominant is your business in your industry? A manufacturer of cleaning equipment with many competitors will have a lower multiple than a company that has cornered the market in a category of computer software.
Your negotiating power will also affect the multiple. If you’re more eager to sell than your prospect is to buy, for example, the multiple will drop.
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