Does the Price of your Business Make Sense?
The price of a business that goes onto the market is critical. If the price is wrong the chances of selling go down considerably. The bad news is that only one in 4 businesses actually sell. Having the wrong price on the business for sale is one of the reason 75% of businesses never sell.
When you think that you have determined the appropriate market price for your business, either by using a formal business valuation or by working with an experienced business intermediary, step back and ask: “Would this number make sense in the real world?”
Give the number one last check by using one or more of the following sanity checks.
Business valuation sanity checks
Industry rules of thumb. Rule of thumb based on percentage of revenue or a multiple of earnings can help support the reasonableness of a market asking price. Rules of thumb are sometimes published in trade journals, they can be passed along by word of mouth or obtained from business broker data.
Rules of thumb are never acceptable as sole methods of valuation. These formulas typically are oversimplified, and do not always take into account the unusual strengths or weaknesses of a subject company. Further, rules of thumb typically estimate the selling price for the entire business and may not include inventory, accounts receivable or liabilities. Most rules of thumb are market-driven; that is, they are a result of actual sales.
Read More Here is more information about valuing a business.
Justification of Purchase (JOP) test. This sanity check assumes the subject company is sold at its marketed value and financed using conventional terms. If the company’s expected cash flow will cover its hypothetical debt obligations, provide the owner a reasonable salary, cover any expected capital equipment expenditures, and provide a reasonable return on capital invested as a down payment, the test justifies the asking price. When using the JOP test, you will need to make various assumptions about a company’s probable financing terms, including the interest rate, debt-to-value ratio or duration. Commercial lenders may help support financing assumptions.
Sanity checks can be useful tools to support your market value conclusions. But they are merely tools and cannot substitute for a full and well-reasoned valuation report.
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