Business owners often wonder, "What is my business worth?"
For public businesses, the stock exchanges (NYSE, AMEX, NASDAQ, etc.) answer this question. The business is worth the price per share of the most recent trade times the number of shares outstanding.
For private businesses, the answer is not readily available. A recent arm's length transaction involving ownership interests would provide an answer, but these transactions occur infrequently. To accurately determine the value of a private business, the business owner should consult experienced business valuation advisors. For those satisfied with a rough estimate, here is a four-step method to estimate what a business is worth.
The first step is to determine the normal level of annual net income. The normal level of annual net income is the total revenue less total expenses that your business generates currently, under normal conditions, after adjusting compensation expenses to reflect industry norms and lease expenses to reflect arm's length transactions.
The second step is to determine the compound long-term growth rate of the normal level of annual net income. The long-term growth rate should reflect growth expected over the next thirty years. For most businesses, this rate will be between 3% and 10%. Although businesses may grow at much faster rates in a given year, it is rare for businesses to grow faster than 10% over any thirty year period.
The third step is to determine the risk factor associated with achieving the normal level of annual net income, including the expected long-term growth, in future periods. A risk factor is derived from the historical returns demanded by investors for public stocks. For example, the historical returns for large public stocks and small public stocks have been around 12% and 20%, respectively. Based in part on these returns, the risk factor for profitable large private businesses often ranges between 15% and 20%, while the risk factor for profitable small private businesses often ranges between 20% and 25%. Businesses that experience wide fluctuations in profitability may have risk factors in excess of 30%.
The fourth step is the value calculation. Calculation A: (Normal Level of Annual Net Income) × (1 + Growth Rate). Calculation B: (Risk Factor - Growth Rate). Value Calculation: Calculation A ÷ Calculation B.
As an example, assume that a business has a normal level of annual net income of $10,000, an expected long-term growth rate of 5%, and a risk factor of 25%. The value calculation would be: ($10,000 * (1 + .05))/(.25 - .05). This business is worth $52,500.
The Malibu Group has significant experience and expertise determining the value of private businesses. We have performed hundreds of business valuations for a variety of purposes including mergers & acquisitions, buy/sell agreements, gift & estate tax planning, fairness opinions, GAAP requirements, S-Corp conversions, ESOPs, shareholder litigation, and divorce cases. Our directors hold professional designations including: Accredited Member of the American Society of Appraisers, Chartered Financial Analyst, Certified Public Accountant, and Master in Business Administration from top MBA programs. Please contact Kevin Kennealy, the Director of Business Valuations, for more information on The Malibu Group's business valuation services. Kevin can be reached at 513-583-5413 ext. 182, or by email at Kevin@malibugrp.com.