Q: I am considering retirement in the next couple of years. How do I calculate a crude estimate for the value of my firm so I can do some basic personal financial planning?
A: A professional appraiser will typically use multiple methods to estimate the value of your firm. Two factors to consider are (1) the going-concern value, which assumes the company will remain in business and continue to be profitable; and (2) the liquidated value that assumes the firm will close and assets will be sold. If the firm owns valuable real estate, the liquidation value could easily be the higher of the two.
Let’s assume that the highest and best use of your company is the going-concern value. In other words, the liquidation value of your equipment, etc., is less than the value of the cash flow generated from running your business. Again, we are assuming a crude estimate.
First, review your past few income statements and look for your Earnings Before Interest and Taxes (EBIT); this is sometimes called your operating profit. Take an average of this amount for the past three to five years.
Next, add to this amount the average depreciation and amortization expense for that same period. This total amount is called Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). Small businesses that are 100 percent equity-financed typically sell for between five to eight times EBITDA. If you are planning on selling the firm and using the proceeds of the sale to pay off your company’s debt, you could sell your company for this estimated price range.
Conversely, if your buyer is simply making an equity purchase, which means that the buyer purchases your equity and the buyer assumes responsibility for the company debt, then the selling price range should be EBITDA times five to eight, minus the company debt.
It is very important to set the terms in negotiation as to who assumes responsibility of the company debt at the time of the transaction, which obviously has a huge impact on the final amount of cash to exchange hands.
This method gives you a rough estimate of value that’s helpful for preliminary planning.
David Vang is a finance professor in the Opus College of Business at the University of St. Thomas and co-author of “Entrepreneurial Financial Management: An Applied Approach, Third Edition.”