If you’re looking to sell your franchise, you need to know what your business is worth. While this is an important question to answer, it can also be challenging. Too often, a business owner inflates the value of a business because they’re emotionally tied to it. After all, if you’ve put your blood, sweat, and tears into building your franchise, shouldn’t it be worth millions?
What is a Business Valuation Based On?
A common mistake owners make is that they believe their business is worth what they have invested in it, either through money or time. Valuing a business is much more objective than that. The value of a business is based on its future cash flow, which usually can be predicted from historical results of sales and profitability. Buyers don’t care how much you spent yesterday, they care how much they can make tomorrow if they buy your franchise.
While, yes, there are calculations to determine the value, ultimately, your business is worth what someone will willingly pay and what you’re willing to accept.
How to Calculate the Value of Your Business
There are some quick ways to calculate your business’ value, such as multiplying revenue by two or multiplying EBITDA by three or four. If you want a more accurate estimate, keep reading, because we’re going to calculate business value using seller’s discretionary earnings (SDE). This is the gross income before non-cash expenses, owner’s compensation, interest expense and income, and any one-off expenses. This is most useful if your annual gross sales are under $1 million.
Here’s the formula to determine your SDE:
(Net earnings before taxes + owner’s draw + non-essential expenses) – liabilities
Once you have your SDE, you can find your business value multiplying it by 1-4. Many factors go into whether you should multiply your SDE by 1 or up to 4, so do some research (your franchisor may even have the answer for you) to determine the appropriate multiplier.
Other Factors That Go into Business Valuation
This is just one method for calculating your business’ value. You can also calculate using EBITDA. If the math gives you a headache, hire a business valuation company to do the work for you. For businesses with revenues over $1 million, this is money well spent. It will not only give you a realistic view of your value but it will also help your buyer secure financing. You’ll likely be asked about the following aspects:
Start by assessing your business assets. You may have equipment, real estate, or machinery that has a value. Realize that equipment depreciates, so even if you paid $100,000 for equipment a year ago, it’s worth a fraction of that today. You can find fair market value for equipment by looking at Craigslist or eBay to see what used equipment of a similar age is selling for.
Also look at your liabilities, especially if you plan to pass them on to the new owner. Do you have outstanding debt or unpaid invoices? Likely, a buyer will ask you to pay these before they buy, so you’ll need to make sure you have enough profit from the sale to do so.
Next, look at your revenues. If you’ve been in business a while, you can get an average that is fairly consistent year to year.
If you are a franchisee, you are part of a system and usually have access to comparable statistics. Talk to your franchisor to see if it has historical data on what other units have sold for. You also can see if other units in your system are listed for sale and what their asking price is relative to their revenue and profitability.
The next step is to talk to local business brokers and ask them what they believe the business is worth and what they could sell it for. In addition to referrals, the best way to find local brokers is to go to websites that list businesses for sale and see who the local brokers are with good listings. Remember that brokers primarily are compensated on a successful transaction. They won’t want to list your business if you are asking an unrealistic price.
Always remember that your business is competing against all the other local businesses for sale. Take a realistic look at what others are asking and where your price should be relative to your revenue and profitability. Consider current economic conditions: if the country is in a recession, you may not be able to command top dollar for your franchise, and should consider waiting until the market picks back up.