by Doug Bend
When buying or selling a small business, there are five ways to determine a fair purchase price:
Look at Similar Businesses
The least accurate option is looking at similar businesses that are for sale on the Internet. The advantage of this option is you can look at similar listings from the convenience of your home whenever you would like.
However, there can be a wide variety of factors that might make the fair market value of the business you are buying or selling more or less than the business listings you review on the Internet.
In addition, the asking price of an Internet listing is often not the ultimate selling price. If you work with a business broker or appraiser, they will have access to comps of the sale of similar businesses both in California and across the country.
You can also multiply the business revenue. While this option is also free, it does not take into account a variety of factors, such as the projection of future revenues or net profits. For example, two businesses in the same industry could have the same sales but one business could net $200,000 a year whereas another business could net $59,000 a year because it has more expenses.
Hire a Business Appraiser
You can have a certified business appraiser do a very extensive valuation. This is often the most accurate valuation of the business because the business appraiser digs deep on your particular industry, market forces, anticipated future returns and other factors. The drawback is it’s the most expensive option and takes several weeks for the business appraiser to complete. But at the end of the process you would have a detailed report of the business’s fair market value.
Hire a CPA
You can also hire a CPA who specializes in valuation work to review the financials of the business and provide a valuation. This is less expensive and intrusive than hiring a business appraiser, but the valuation is also not as detailed. You should ask the CPA how much experience they have doing valuation work and whether they have been certified by the AICPA or the CBV. Most have no formal business valuation experience and are not certified to provide valuations.
Work With a Business Broker
If you are selling a business, you can have a business broker review your business and provide you with a suggested listing price.
If you are buying a business, a business broker can advise you on whether a listing price of a business is fair or if there are better opportunities on the market.
The advantage of working with a business broker is initially it’s often free. Business brokers are typically only compensated if the sale of the business is completed.
The drawback is if you do not work with a trustworthy business broker who keeps your best interests in mind, they might suggest a listing price that is less than the full fair market value to encourage a quick sale and quick commission payment.
It is fair to ask the business broker how many sales they have completed and hire one who has completed at least fifty transactions. They are more likely to have the necessary experience and competency.
If the broker provides you with a suggested valuation, you should request that they provide you with comparable sales to make sure it is a logical sales price.
Some business brokers are willing to credit the cost of a business valuation by a certified appraiser from their commission if the seller agrees to list the business at the valuation price. For many business owners, this is the best of both worlds as you get a detailed, accurate valuation by a certified business appraiser, but the cost is paid by your business broker.
This article was co-written by Doug Bend and Tucker Cottingham. Doug Bend is the principal of Bend Law Group, PC, a law firm focused on small businesses and startups. He is also the General Counsel for Modify Industries, Inc. and tIFc LLC and a Legal Mentor in The Hub Ventures Program.
Disclaimer: This article discusses general legal issues, but it does not constitute legal advice. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article. If you have any questions about buying or selling a small business or would like an introduction to a great CPA or business broker to help you value a business, you can contact the authors at (415) 633-6841 or firstname.lastname@example.org.