Thursday, November 7, 2002

Two weeks have come and gone since my last entry, and I have to admit, it's been an anxious time. Besides pretending to be a normal small business owner, I've been coming home most nights and trying to digest these "How to buy or sell a business" books. I've tried to do my homework, working through several business valuation examples, but I have to say, I find the array of valuation formulas very confusing.

Based on the business valuation formulas and rudimentary examples found in four "How to Sell Your Business" different books, it looks like our company is worth anywhere between $315K and $5M. (This is based on selling all 100% of our company at one time.) As you can guess, that doesn't really narrow it down much.

Business valuation methods

It turns out there a lot of different ways to value a business, including:

  • Book Value Method
  • Multiples of Revenue
  • Capitalization of Earnings Method
  • Continuing Value Method
  • The Excess Earnings Method
  • The Asset Value Method

There are even more business valuation "methods" than these, but these are the ones I see repeated in the four books I have, and in the other research I've done on the internet.

Trying a business valuation

With our business being a service-oriented business -- and with me being more of an engineer and less of a financial person -- the only business valuation approach that make sense to me is (1) to try to determine the net income from ongoing operations, (2) make some assumptions about how the company would change after the sale, (3) make some assumptions about business revenue after the sale, and (4) try to determine the income to the new owners of the business.

Without using any technique, I know that with our current situation our net income has been over $315K per year lately, I have to think the overall company is easily worth that, or even twice that ($630K). This has to be tempered by the fact that many of our employee-owners will want raises if they sell their interest, but still, it's a place to start.

Some of the techniques show that our company may be worth as much as $5M, though I don't understand how that can be possible. Taking the rough middle ground between a low of $335K and a high of $5M, I'll guess our company may be worth $2M, though I'm not at all confident in that number.

I have to say, it's a nice feeling to think that you've created a company out of thin air, and a decade later this company may be worth $2M. It isn't a huge fortune, but hey, it's something.

As I read all these books and go back over Marty's paperwork, it's interesting to learn that there is a profession known as "business valuators", people who are hired to determine the value of a business. I knew a little bit about this before, especially because our business Operating Agreement has a clause in it that a business valuator may have to be used in the event of a partner separating from the business, but I didn't create this business with the idea of selling it one day, so it wasn't anything I gave a lot of thought to. (Frankly, I don't know exactly why I created this business, other than my inability to be satisfied working for other people.)

Discounted future cash flows

As a final note here tonight, I keep reading about "discounting future cash flows" (Wikipedia link), which is a new term to me. (Which may show how much of a novice I am about business financials.) I think what they're saying is that a dollar you hold in your hand isn't going to be worth as much in the future. Just considering an inflation rate of 4% annually, one year from now that dollar will be worth 96 cents, and two years from now it will be worth about 92 cents, then roughly 88 cents, and so on. There's more to it than this, but I think that's the basic idea behind it.

I was reminded of this as I was just thumbing through one of these books again, and ran across this quote:

"The theory behind discounting future cash or cash equivalents to a present value is that a dollar received today is worth more than a dollar to be received in the future."

This isn't a big deal to me right now, but it looks like something a business valuator needs to consider when looking at a projected future income.

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