WHAT'S YOUR COMPANY WORTH?
Posted by Tom Gledhill on Tue, Jul 14, 2009 @ 01:53 PM
Most business owners have a dollar value in their head about what their company is worth. And most of them are wrong. The vast majority of business owners overestimate the value of their business. They factor in the sweat equity that they put in starting the business, the long hours they spent building the business, the infrastructure that they've built, the employees they've mentored, and the customer and vendor relationships that they've developed. But in the final analysis the determining factor as to what your company is worth is: How much money is the company making?
Over the years I've had several people approach me with products or services that they've developed but had no money or expertise to market them. They had no revenues and no immediate prospects. They had no patents and their intellectual property was minimal. In cases like this, with no revenue and no track record, it's extremely difficult to find a buyer. Best they try to find a partner to invest some marketing money to get the company off the ground. Unless you have a product or service that is patentable and world-changing, a company that has zero revenues is worth just that - zero!
Several years ago I represented a company in the boating industry. I liked the owner and I liked the product. He had developed several channels of distribution and had good prospects for future business. Based on his financials and other parameters, I estimated that his company could sell for about $300,000. He seemed to accept that. I put together the marketing materials and developed a marketing plan and began implementing the plan. I did receive a couple of offers in the $300,000 range. I knew that the owner had three brothers that owned an interest in the company and I assumed that they had agreed to my estimate of value. How wrong I was! They flatly rejected the $300,000 offer. They (the brothers) said that the company was worth a Million dollars and they were not going to sell it for a paltry $300,000! The rest of the story - they never sold the company. They closed their doors about a year later and sold the remaining raw inventory for pennies on the dollar.
Except in rare industries, the value of a small company (typically under 2 million in revenue) is a multiple of Sellers Discretionary Earnings (SDE). SDE is defined as operating income (with re-castible adjustments) plus owner's salary. The multiple is typically between 2 and 3. It can be less than 2 if growth is negative, reputation is not good, location (if a factor) is not good, key employees are not staying, customer and vendor relationships are not good, etc. On the other hand, it usually takes all of those factors to be positive in order to rate a multiple of 3.
In the boating industry case above, the brothers would have needed an SDE of about $400,000 with a multiple of 2.5 (which I thought was about right) in order to justify a value of $1,000,000. Since their SDE was only about $120,000, the company was only worth about $300,000. Buyers use the same methodology to determine a fair price, so if you use something different that yields an inflated value, you'll be spinning your wheels if you try to sell at that price.