Valuation is one of those four-syllable business buzzwords you’re going to have to deal with, eventually, if you either want to start a business or own a business. If it doesn’t come up when you start, it will come up later. Here is what I think you need to know, in five short points.
1. The word has vastly different meanings: don’t you hate it when the same words mean different things? Valuation means at least three different things:
A. What a business is worth to accountants for legal purposes, such as divorce settlements, inheritance taxes, and gift taxes. A certified valuation professional, usually a CPA, makes a guess. Most of them use financial statements and analyze financial details.
B. What a business is worth to a buyer. Small businesses go up for sale with business brokers. Hardware stores, for example, get about 40-50 percent of annual sales plus inventory, as a starting point. Plus a bonus for growth and special strengths, or a discount for lack of growth and special problems.
C. The pivot point in an investment proposal: it’s simple math, but tough negotiations. If you say you want to get $1 million for 50 percent of your company, you just proposed a valuation of $2 million.
2. What’s anything worth? Like your car, your house, and a share of IBM stock, something’s worth what somebody will pay for it. The valuation in A is theoretical, hypothetical, but legal. With B and C, though, valuation is as real as agreeing to buy a house. It’s not what the seller says it is; it’s what the buyer is willing to pay. And this cold hard fact drives many entrepreneurs crazy.
3. For small businesses, there are guidelines and rules of thumb. If you do a good search, or work with a business broker, you can find general rules of thumb for what your long-standing small business is worth. For example, a hardware story is worth roughly half a year’s sales plus inventory, with bonuses for positive factors like recent growth, and discounts for negatives like lack of growth. You could read up on it in Bizbuysell.com, Bizequity.com, or Business Brokerage Press. Or do a Web search and check the ads for valuation experts.