How much is my business worth? The short answer is its worth as much as you can get for it and as much as someone is willing to pay for it.
When a change of ownership occurs, the price paid is said to be fair market value. The appraisal industry defines this value as the price at which a business would change hands between a willing and knowledgeable buyer and a willing and knowledgeable seller.
To illustrate: some years ago, I prepared an opinion of value report for a full-service wash with annual sales of $1.5 million and pegged the market value at $3.0 million.
The wash sold later that year for $4.2 million. Here, net operating income was $350,000 which translates to a capitalization rate of 8.3 percent. My opinion of $3.0 million indicated a cap rate of 11.7 percent and was comparable to market rates at that time.
So, did our willing buyer knowingly pay too much for the business? If so, can $4.2 million then be considered a fair market value? In this example, the principal involved is an absentee owner. The subject is a traditional full-service wash and more than 30 percent of sales came from the detail shop. Consequently, the labor burden is around 50 percent of sales revenue plus a management fee of more than $100,000.
There are also other reasons for knowing how much a business is worth. A business valuation can help lay out the groundwork for retirement. It can paint a picture to make buy/sell transactions easier. It can identify weaknesses that are hampering growth.
Obtaining a business valuation is relatively easy, but obtaining an accurate valuation is another matter.
Long ago, business owners would rely on rules-of-thumb to ponder a market value or engage a third-party to prepare a report. Third-party meant a summary property appraisal prepared by a certified appraiser or an opinion of value report prepared by a broker, real estate professional, or car wash consultant.
Depending on the complexity of the business, a summary appraisal may cost between $3,500 and $6,000 whereas the less formal opinion of value may run $1,800 to $2,500.
Today, however, the Internet of Things has created a cornucopia of potential valuation solutions. As for rule-of-thumb, there are experts posting on blogs who suggest car wash owners ponder a value based on multiple of earnings (current 12 months) adjusted for the size of the business.
Other experts suggest valuing a business based on multiples of income (current 12 months) adjusted for product class and business size. While yet others suggest using earnings multiples adjusted for type of premises (owned or leased).
There are also a host of online business valuation services. Here, the client goes online, fills in the blanks with required information, and an automated valuation model calculates a value and produces a 12-page report (PDF). Price is based on the length of time the client has access to the valuation (e.g., three months access is $250).
There is also a slew of e-valuation providers to choose from. Here, I found one blog that listed 25 services from places around the globe. For example, I came across one person from the Czech Republic offering to value private equity start ups for only $150.
There are also a number of free online DIY valuation services, shareware, and even a mobile app. Some of these tools are easy to use, some are not. Moreover, as with the other valuation sources we mentioned, there are the issues of accuracy and precision to consider.
To illustrate, we evaluated some of these tools to see how the results stacked up with conclusions reached by traditional means such as appraisers and industry experts.
As shown in the table above, DIY valuation tools produced considerably different results as compared to the appraisals. The principal reason for this is differences in method and process.
For example, property appraisers arrive at a concluded market value by reconciling the cost approach, market approach, and income approach to value. Brokers and consultants typically rely on the income approach in preparing an opinion of value. Free online valuation services and DIY shareware also rely on the income approach, but we found the processes vary considerably.
Methods and techniques used by for-hire online services are proprietary or, at best, only a general description is provided on how it works.
Conversely, the process that appraisers use with the income approach is straightforward. Here, value is calculated by capitalizing stabilized net income where net income is a function of stabilized income and expenses for the previous three years.
Common methods to determine a capitalization rate are band of investment technique and direct capitalization approach. With the latter, cap rate is calculated as a function of the discount rate and long-term growth rate. With the former, cap rate is calculated as a function of return on investment and mortgage and equity requirements.
Cap rate can also be derived from comparable sales data with financial history.