Selling a business can be an emotional process — especially for business owners who have spent years building their companies. A successful sale has to work for both the buyer and the seller. For sellers, understanding the value of the business and what they’ll walk away with after a sale will help ensure they leave the negotiation room with confidence in the decision to sell.
When starting the sales process, one of the most difficult questions for a seller to answer might be, “what is my business worth?” Business valuation experts use three main approaches to determine this value - the asset approach, the income approach, and the market approach.
The asset approach starts by establishing the current fair market value of a business’ assets and liabilities (debts). The liabilities are subtracted from the assets to determine the value of the net equity. Both tangible and intangible assets are reviewed to determine value. This approach is typically used for companies that are asset-intensive, and perhaps, underperforming.
The income approach looks at the future of the company – specifically the potential of future cash flow. Calculating value using this approach involves using the capitalization of earnings method or the discounted cash flow method. Both methods of calculation set the value by relying on various assumptions about the business at-present and its potential for future cash flow. Disconnect between buyers and sellers often occurs when there are differences of opinion about the future prospects of the company and the risks associated with the future.
This approach uses the sales of other companies (either closed sales of privately-held companies or sales of public company stock) to determine value. The other companies are selected for similar features and are called “comparables.” This approach uses the final sale price – what buyers were actually willing to pay and did pay for a business. Factors beyond the business’ characteristics - such as days on market, geographic region, past and current economic and market conditions, etc. - can affect the comparability of one business to another.
WHAT DOES THE VALUE OF MY BUSINESS REALLY MEAN?
Ultimately, the value of a business is the amount a buyer is willing to pay for it, but a business valuation gives a starting point to determine its economic value and open negotiations. Once a final price is agreed upon by both the buyer and seller, the type of sale selected and other transaction terms can greatly impact the proceeds a seller receives. There are two main types of sale options, each with its own pros and cons:
In an asset sale, the seller retains possession of the legal entity, and the buyer purchases specific, identified assets of the company – tangible or intangible. The seller typically retains the long-term debt obligations. Which means even if a seller is happy with the final sale price, they could still be responsible for a large amount of debt — which will reduce the total proceeds that can be enjoyed after the sale.
In a stock sale, the buyer purchases a seller’s stock and takes ownership of the legal entity. Assets and liabilities are acquired. Any assets or liabilities the buyer deems undesirable or doesn’t need can be distributed or paid off prior to the sale. Assets and liabilities are the property and obligations of the company, so these do not typically have to be specifically outlined in a stock sale. Buyers absorb more risk – both known and undisclosed.
As a seller, consider how you might benefit from both sale options. Once you understand what your business is worth, how might the sale of assets or stock impact your net proceeds – the amount you actually put in your pocket? Will higher taxes from an asset sale hurt you? Are the liabilities you’re left with too great? What other important factors could you be overlooking?
To learn more about the intricacies of buying and selling a business, download Mergers & Acquisitions Guide: What You Need to Know Before Buying or Selling a Business.
ABOUT THE AUTHOR
Eric Larson, Beene Garter Partner, CPA/ABV, ASA, CBA, CMA, CFE
Eric has extensive practical and theoretical experience in the field of financial valuation, transaction negotiation, merger/acquisition representation, and corporate financial analysis. His business valuation projects have been performed for numerous purposes, including estate and gift taxation, succession planning, employee stock ownership plans, purchase and sale advisement, purchase price allocation, fairness opinions, marital dissolution, and other tax and corporate related matters.
Eric has performed financial analysis, valuation and transaction consulting across a wide range of industries, including agriculture, general and specialty contracting, plastics and metal manufacturing, packaging and printing, automobile and truck transportation, finance and insurance, healthcare, professional and technical service, restaurants and retail, and wholesale distribution of specialty and commodity products. Eric currently serves as an adjunct faculty member in Grand Valley State University’s economics department.