What is Your Business Worth? 6 Rules of Thumb to Consider
By: Justin Farmer
I work with extremely successful and exceptionally bright professionals who, after years of hard work, have grown a business that has going concern. But like most savvy business owners, my clients come to realize that it is time to transition and “pass the baton”, so to speak, to a younger professional who can carry the business into the next generation. But selling a business is a lot of work. And certainly selling a professional service business must be harder (or so many of my clients think). Then the question remains: is it worth it? The short answer: absolutely. Sure, there are countless moving parts and factors to consider when selling a business. But with the proper planning and team in place, you can maximize your return on investment.
Now that you have decided to sell your business, I am sure you are longing to know how much value can be obtained from selling it. And, even more, how do you go about determining value? Let me speak candidly for a moment: valuing a business, which has grown organically over the course of 20+ years, is no easy task. And while business valuation is not an exact science, I can assure you that there is a way to determine, with 100% certainty, what the value of your business is: put it on the market!
If you don’t want to test the market before having a general idea of what your business is worth (a good idea), take a look at the following six general rules of thumb. With some objective reflection, you should feel confident in what the market will bare when you put your business up for sale.
- Starting Point: In general, the starting point for the value of a law practice begins at 0.9-1.0 times annual gross revenue. If you have an accounting practice, the starting point is closer to 1.0-1.2 times annual gross revenue. Other private practices, like medial or dental, have yet a different multiplier. But as you apply the following factors, you can expect the multiple to increase or decrease slightly.
- Payment Terms: Cash is king. You should plan on having both a cash (lower) and seller-financed (higher) price in mind. For instance, if a buyer brings 100% of the purchase price at closing (or darn near), then you should be willing to take the “lower” cash price as the risk of not getting paid falls close to zero. Conversely, if you are willing to finance all, or a majority of the purchase price, then the total purchase price should be higher.
- Ownership Transition: The more you are willing to provide by way of transition assistance, the higher the potential multiplier. Keep in mind that with either a cash or financed price, the buyer is paying you for a certain amount of transition assistance. As a seller, you should expect to provide transition services as part of the deal, including making introductions to key clients, referral sources, and the like. But the more you are willing to help ensure a successful transition, the higher the value to the buyer and, therefore, the larger the multiplier you are likely to receive.
- Client Relationships: Continued patronage from repeat clients is an important factor that you should be tracking long before taking your business to market (if you aren’t tracking this, start now). The more you can show that revenue is tied to clients that come back month-over-month or year-over-year (depending on your practice), the better. Think about it: your business is attractive so long as revenue is coming in the door with or without you. So, the more automatic the reoccurring revenue is, the higher the multiplier you can expect.
- Client Concentration: Having revenue concentrated with one or a few “large” accounts can sometimes cause a decrease in potential value of a professional service business. However, the contrary is also true: having no concentration, but revenue that is spread across a variety of clients, can actually increase value. If you do not have a high concentration of revenue tied to any one large client, then you have minimized the risk of losing a substantial amount of revenue if any one client were to leave, thus creating a higher potential multiplier.
- Profitability: Last, but certainly not least, is profitability. How much does it cost to run your practice? How much cash do you have left over at the end of the year? If you are running a professional service business with overhead of 50% or less, then you are in very good shape. Having healthy net income and gross revenue that is growing year-over-year shows a potential buyer that there is less risk of drop-off in the future. And when it comes to determining value, and ultimately finding a buyer who can obtain financing, profitability is something that a lender looks very closely at to determine if the business can service future debt. In sum: higher and/or increasing profitability = higher multiplier.
As you can see, determining the value of your business is really one part science, one part art, and one part math. And while, ultimately, you can assign any multiplier to your business that you want; the true test comes when you take your business to market. Until then, the above should get you moving in the right direction until you are ready for the market to set the actual price.