One of the biggest questions business buyers and sellers have is: “What is this business worth?” The answer is never easy, but we can start by discussing some of the approaches business brokers and advisors take when we value a business. We will also discuss some recent research on Canadian and U.S. business transactions, the findings of which are relevant and revealing.
Valuation Approach
Generally speaking, there are three approaches to value a business:
- Based on assets
- Based on income
- Based on market comparables
While all three approaches are typically reviewed before a final determination of value is made, they are not additive. We can’t, for example, add the value derived from the income approach to the value of the assets for an accurate result.
The more comparable the asset, the easier it is to apply market comparable approaches. The best example of this is residential real estate: we can estimate a house is worth around $150,000 because a similar house next door to it just sold for $150,000. Of course, no two homes are alike, so we adjust for certain factors: the extra bedroom is worth an additional $10,000, the smaller kitchen costs you $5,000 (these numbers are by way of example only).
Unfortunately, when it comes to businesses, almost nothing is directly comparable. Values differ widely based on location, revenue, costs, profitability, management… the list goes on. That is why businesses are typically valued based either on income that the business generates or based on the sum of its assets that can be valued separately.
Of course, valuing just the tangible assets typically ignores the “goodwill” a business holds – the intangible value that can make a business worth buying or, for the seller, makes their sweat equity real. Valuing goodwill is tricky. That is why we typically start by looking at the income a business generates to determine its overall value, then compare that number to the sum of all tangible assets to determine goodwill.
Recent Research
So much for theory – what do the numbers say? While it is always risky to rely on comparables for businesses, they do shed some light on the overall market.
Recently, BEAL analyzed over 10,000 transactions of businesses across North America, and attempted to isolate the “goodwill” component. What we found is revealing and instructive, especially for Canadian businesses. Generally, people assume Canadian businesses sell for less than US businesses. This is true – but only up to a point. The “multiples” of income that Canadian businesses get are very similar on average to those in the US, but the multiples relating to pure goodwill are lower – about 30% lower.
What does this mean? While Canadian businesses are doing fine, those looking to sell need education to maximize their goodwill. The business buying market is less robust in Canada than in the US, where buyers are willing to pay more for the intangibles.
That is where BEAL can help. We enable business to owners maximize the value of their business both before and as they sell their business. In the meantime, if you would like more information on buying a business, contact us at 204-478-7266×110.