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Net Asset & Goodwill Valuation Principles for Selling a Small Business

When you consider selling a small business, there are a few ‘typical’ ways in which a small business can be valued. One way is to determine the net value of the business’s tangible assets such as equipment, machinery, inventory, furniture, etc.  Another ‘typical’ way a small business is valued is on the basis of a multiple of Seller’s Discretionary Earnings (SDE).  

It is important to understand when to use which approach and the implications to you as a small business owner looking to determine the selling price of a business.

Valuing a Small Business Based on Net Asset Value
If you determine the value of a business based on the net asset value, you essentially determine what the current value of the business’s assets is and set the selling price on that basis.  This method is not typically used for business ventures that are a going concern.  Using this approach does not assign any worth to future cashflow generated by the company.  It is an ‘asset sale’ in the truest sense of the word.

This approach also has a perception issue.  Often, the business seller will always think that the value of the hard assets is at or close to the original purchase price.  The buyer, on the other hand, looks to a figure that is often referred to as ‘auction value’ which is usually around 10-20% of the original cost.

Valuing a Small Business Based on a Multiple of Earnings
This approach takes an appropriate multiple of SDE (pre-tax operating profit, amortization, depreciation, interest, personal expenses, salary for one owner/operator, and other discretionary items).  The value determined using this method that is over and above the net asset value of the business is an intangible called goodwill.  The key point to remember here is that this approach makes sense for most small businesses for sale that are going concerns.  In other words, if the company is sustainable, profitable and will be generating positive cashflows to the owners, then goodwill is the value placed over and above the tangible assets.  Goodwill can also reflect the brand recognition a business has in the community and other intangible things like employee and customer loyalty.

When you do decide to sell your business talk to an experienced business broker and certainly do consult with your accountant or business valuator to assist you determine the appropriate selling price.  As a company owner, you don’t want to leave money on the table, so to speak, and you certainly don’t want to price yourself out of the market either.

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