If you are looking to sell your small business or plan to buy one, the central question is what the business is worth on the market.
Overprice your business, and you will see little buyer interest. If your asking price is too low, you risk leaving a lot of money on the table. Knowing the market value of your business helps you set the asking price that attracts qualified buyers – and results in a successful business sale.
Equally, if you want your offer to be taken seriously by the business seller, your price must reflect the realities of the business market place.
Beyond business acquisitions, business market value is key to establishing the business worth in a number of important situations – in legal disputes, business partner buyout situations, and in dealing with the tax authorities.
A solid evidence of what the business is likely to sell for if put on the market is often the most convincing proof of its value.
And there is no better way to estimate the likely business selling price than comparing it to the actual sales of similar private businesses.
Private business sales are very different from sales of public companies
Be careful looking at the sales of publicly traded companies when estimating the value of a private business. Valuation multiples for public companies are likely to be very different than those you get form private business sales.
Here are the top three reasons for this:
- Small private businesses are less marketable than large public firms.
- Small business sales are done on the controlling ownership basis. Most public company stock sales are non-controlling.
- Small businesses are more risky and their valuation multiples reflect that.
Small businesses are less marketable than big company stock
If you own shares in a large publicly traded company, you can sell them within minutes by placing a market order through your broker. And you can get your money the next business day. More importantly, your actual selling price and the market price per share just before the sale are likely to be very close.
In contrast, selling a small privately owned business is a lengthy and uncertain proposition. Small businesses take 6 to 9 months to sell on average. Finding the right buyer, negotiating and closing the sale cost time, money and effort. And there is no certainty that your actual business selling price will be close to the asking price.
In formal terms, small businesses are illiquid investments, unlike shares of stock in publicly traded companies, which are highly marketable.
This lack of marketability of small business ownership interest leads to significant discounts being applied by investors, such as financial business buyers. In other words, the buyers want to be compensated for taking the risk – and they do so by lowering the price they are willing to pay for a private business.
Valuation multiples you get by comparison to small business sales reflect this risk. Public company share price ratios do not.
Small business vs big business: what sells?
Most investors in public companies trade a small number of shares. When a large company is acquired, the buyer typically pays a premium for getting a controlling stake in the business. It is not unusual to see the control premium in the 50% – 80% over the market price of the company’s shares.
Almost all private business sales are done on the controlling ownership basis – the entire business sells. If you were to use the price per share numbers based on the public company data, you could be 80% wrong!
Again, valuation multiples derived from sales of similar small businesses are based on sales of the entire business. This is not the case for public company data.
Small businesses are more risky
For a proof of this take a look at the stock market to see that small firms tend to generate higher returns than, say, Fortune 500 companies. Put differently, investors use lower valuation multiples when pricing shares of smaller companies.
Best way to estimate business market value?
For accurate estimate of your business market value, you should use valuation multiples derived from the actual sales of similar small businesses. These businesses operate in the same industry, are privately owned, and are about the same size as your company.
Make relevant comparisons!
Such “apples to apples” comparisons can give you a very reliable estimate of your what your business is worth on the market.