How to Value a Business When Buying or Selling It

Did you know that many real estate companies offer assistance with more than buying and selling property? They also help people buy or sell businesses. Before a transaction can take place, however, a value for the business must be established.

The first step in valuing a business is quantifying the value of its assets, including office furniture and equipment (e.g., desks, chairs, computers, phones, photo copiers, etc.), as well as industry-specific assets like software and hardware. Industry-specific assets are invaluable to people in the industry and fairly useless to anyone else. A manufacturing company, for example, wouldn’t have use for restaurant equipment, nor would a retail shop be interested in mechanics’ tools. However, if a real estate broker wanted to purchase a real estate company, he or she would be thrilled to discover that the existing owner invested $50,000 to develop proprietary software that streamlines the business and provides a competitive advantage.

After the assets are valued, it’s time to do the same for inventory. While service-related companies may not have much in the way of inventory, a car dealership may have millions of dollars worth of inventory. For a manufacturing company, three types of inventory exist: raw materials, work-in-progress (partially finished products), and finished goods—and all must be assigned a value.

Other assets, ones that are harder to quantify, are customer and supplier lists and relationships. What is it worth to have customers who return to this business time and again for their product or service, because the customers trust that the product or service will be of a known quality and delivered in a way consistent with their past experience? In some cases, this good will allows companies to sell their product or service for higher than the going rate. Think about it, wouldn’t you pay a little more at a restaurant for your favorite meal to be prepared perfectly without a wait every time?

If a company has no good will, the value of that company is the liquidation value of its tangible assets and inventory: the amount it would earn if it sold everything at a fire sale. Unfortunately, for most small businesses this is the maximum price for their business, which is why so many go out of business rather than sell. If the profits generated by the business minus the value of the owner’s time produce an income sufficient to convince an investor to put up hard-earned cash, then that business has good will—and many businesses do.

When considering business value, the owner must figure out the value of his or her contribution—what would it cost to replace the owner? If the company’s net profits are $30,000, but the value of the owner’s contribution is $50,000, then the value of the business probably is the liquidation value. On the other hand, if this same business nets $100,000 a year and the owner could be replaced for $50,000 a year, the sale price of the business could be in the neighborhood of $250,000.

Now comes the tough decision: To truly value a business, you have to look at the prognosis for future success. Will profits continue at existing levels? Did the profit come from one rare and wonderful transaction that probably won’t be repeated, or from thousands of transactions from customers with 10-year contracts? Is the business relying on technology that will be obsolete soon or is it a Laundromat in a low-income part of town?

A cautionary tale: ten years ago Blockbuster Video appeared unstoppable, but once Netflix hit the scene, the prognosis for Blockbuster profits declined dramatically. The person who will succeed in business is the one who can see the next Netflix.

If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.