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“How much is my business worth?” or “How much should I pay for this business?” are the typical questions business owners ask us. What these entrepreneurs are often seeking is validation of what they intuitively believe to be the value of the subject business.
As Chartered Business Valuators, we enquire, analyze and apply valuation principles and judgment when determining the fair market value of a business. Business value can be summarized by this simplified formula:
The sum of the value of: net tangible assets plus intangible assets, or goodwill.
In many situations, determination of the fair market value of net tangible assets (i.e. the working capital, equipment, land and building) is fairly straightforward. The value of goodwill on the other hand is elusive and often not recorded in the financial statements. Understanding the components of goodwill and how it drives overall business value is critical to maximizing that value.
In order to be commercially valuable, goodwill needs to be capable of being effectively transferred to a new owner. Personal goodwill (which attaches to a person as a result of their personal qualities, reputation or relationships) is valuable to that person alone and cannot be sold to a third party. Therefore, it has no value to an open market acquirer.
Successful business owners contemplating an exit are often surprised to learn their business valuation expectations are not met because they fail to recognize that business success is a function of their personal customer relationships or they possess process knowledge that has not been effectively transferred to others in the organization.
This table presents a categorization of intangible assets with examples of items we typically see.
Identifiable intangible assets are especially valuable to the business because they are often legally protected or difficult to replicate and so provide competitive advantages and/or barriers to entry. These intangible assets can reduce risk, increase growth potential and thus increase overall business value. While intangible assets can drive business value, there are higher risks attached to these assets because of their intangible nature. Unlike long-lived and more readily marketable physical assets, such as real estate or equipment, intangible assets have the risk of becoming obsolete, redundant or expired.
In addition to these identifiable intangible assets, goodwill refers to more general and typically non-identifiable or non-separable assets such as:
As you prepare your business for sale, contemplate converting personal goodwill into commercial goodwill. Customer relationships as well as business know-how can be shared with other employees in order for the business to run independently of the owner manager (which will make it more attractive to buyers).
In addition, consider the merits of legal protection, through more formal arrangements/contracts with customers, suppliers, distributors and key employees. It will provide comfort to the purchaser that the business will continue status quo without your involvement.
This article was originally published by Canadian Capital on May 13, 2011. Read the original article here.
Steven Hacker, CA, CBV and Amanda Salvatori, CA, CBV are Chartered Business Valuators with the firm Meyers Norris Penny LLP.
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