Our attorneys at the Franchise & Business Law Group have represented clients in various business sale transactions. In the case of a business sale, we work with our clients to determine the appropriate valuation methodology. In our experience, there are a number of different ways to value a business. Three common methods are:
- Market-based business valuation
- Valuation based on a multiple of the income or revenues
- Asset based valuation
1. Market-based business valuation
Similar to establishing the purchase price of a home, one of the most compelling factors in the value or purchase price of a business is what similar businesses are selling for, or in other words comparables. Websites such as www.bizbuysell.com, www.bizquest.com, and www.us.businessforsale.com are three good places to start. Generally, it is good to compare factors of comparable businesses such as asking price, cash flows, size, years in business, etc.
2. Valuation based on a multiple of the income or revenues
- One of the most common ways to set the value of a business is three to five times (3x-5x) EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization).
- Another common multiple is 2-3 times pre-taxed income, plus the value of the inventory/assets.
- Lastly, another valuation multiple is the total revenue multiplied by 25% to 35%, plus inventory/furniture and fixtures.
3. Asset based valuation
Under the asset based valuation method, the buyer purchases the assets of the business, which can include tangible assets such as equipment and inventory, as well as intangible assets such as a trademark and goodwill. Typically, the purchaser does not purchase the liabilities of the company but assumes the operational costs, such as the lease and certain vendor agreements.
If the purchaser will be purchasing the entity of the seller, then the parties will generally enter into a stock purchase agreement (corporations) or an ownership interest purchase agreement (LLC’s). This means the purchaser will be purchasing the entity and will generally assume the same EIN, as well as all the assets and liabilities of the company. If the purchaser will only be purchasing the assets of the company, the parties will generally enter into an asset purchase agreement, which will designate the assets being purchased and spell out which liabilities, if any, will be assumed by the purchaser.