THE TRICKS TO SELLING A BUSINESS FOR WHAT IT'S WORTH
The Castleman Law Firm
Q: I am interested in selling my business, how do I figure out what it's worth?
A: Valuation of a business is sometimes more art than science. The basic rule of thumb is that the business is worth whatever a buyer is willing to pay. That may sound glib, but there are ways of "helping" a buyer decide that the amount you would like to receive is the amount he is willing to pay. One of the most common ways is to show a prospective buyer what others have recently paid for similar businesses. This method may be difficult to use, especially for small business, since the information may not be publicly available. Business owners may also use the "book value" of their company, or the market value of assets, or some multiple of profits or revenue.
One of the most popular methods of valuation today is the Discounted Cash Flow (DCF) method. This method assumes the business worth is related mainly to the amount of free cash (normally earnings before interest and taxes, or EBIT) it generates, and that some multiple of that free cash amount is the correct way to value the company. The mathematics are a little complex for this short article, but the basic formula reduces to its net present value the value of the future free cash which will be generated by the company. The future free cash is inflated by expected growth rates, and multiplied by an industry multiplier (usually around 3-6 times free cash). This calculation is typically done using several different sets of underlying assumptions, such as growth rates, discount rates, industry multipliers, etc., to develop a range of values for the business. After that, good old negotiation takes over. There are many attorneys and CPAs who are very active in this area.
Q: What kind of issues are involved in the sale of a business?
A: Once the purchase price is agreed upon, the main issues tend to be related to the buyer and seller's respective responsibilities for liabilities, the proper allocation of the purchase price to the underlying assets of the business, and non-competition agreements. The buyer wants to be assured that it won't be liable for acts committed by the company or its employees prior to the date of sale, and the seller wants to ensure that it won't be liable for the acts of the buyer after the date of sale. Allocation of the purchase price between fixed assets, inventory, accounts receivable, covenants no to compete, customer/client lists, business records, and intangibles, such as goodwill and current concern value, have important tax implications.
Non-competition agreements, while generally not enforceable in California against employees, are normally enforceable in California against employees, are normally enforceable when executed in connection with the sale of a business. The terms are negotiable by the parties, and the buyer and the seller have clearly conflicting interests in this document. The buyer would like the covenant not to compete to last as long as possible and prohibit the seller from engaging in any remotely competitive business. The seller generally prefers the contrary.