By "what's my business worth?", are you asking about "business valuation," or "business pricing," or something slightly different?
Price is seldom Value. They are usually different numbers. The degree of difference will change with circumstances. Sometimes the difference will be large. Mostly, it is small. From time to time the answers will coincide with what the business is worth to you.
Let's look at something we can all relate to
If buying your daughter a car will improve her life, it will improve yours too. The asset has value in its ability to add utility to both your lives. To her, the value added is obvious. The value to you in future time saved from being an unpaid taxi driver is quite possibly more than the price tag. So you agree to buy her a car.
But not all cars are created equal and you have a very big selection of vehicles from which to to choose.
A new Renault Kwid will yield the same time-saving value to you as buying her a Mercedes G350 AMG. The price of the G-Wagon will almost certainly be many multiples its utility value to you, and is likely an overkill.
Generally speaking, nobody will argue that there is more value in the Renault than in the Mercedes, even if the utility is the same for both. That extra value comes from other inputs: build quality, comfort, longevity amongst them. But also, the resell price of the vehicle at some future date is also key.
So what is my business worth?
A browse through the businesses for sale web pages will suggest that the asking prices of businesses are more or less related to their profits. Except that is often not the case. Lazy negotiators will toss around "we only pay on a 3 PE" they may say. If we relate that argument to the cars, then the Mercedes should sell at more or less the same as the Renault.
But why are the negotiators wrong? In another example, if a burger franchise makes the owner 100k per month, why shouldn't it be priced at the same number as a software developer which also makes 100k per month? This is exactly what business brokers will often argue.
What are the real differences which will almost certainly make the one more valuable than the other?
The burger franchisee has close to zero exposure to a single big customer, while software developers almost invariably work for a few customers from whom they take "briefs", and sweat like hell until they can sell whatever it is to similar customers, or get retainers signed. They need security of income.
But once the software developer has cracked the code and attracted a market, the cost of sales becomes almost negligible. Each new customer will simply download the software, install it, and apply a licence key which will remain valid as long as they pay on time. The burger guys in the meantime have a cost of sales mostly in direct proportion to sales.
The burger guys will have a lease for that centre, and if you have ever rented in a centre, without a strong franchisor behind you, you will know how dodgy that can be when time comes for renewal. The software guys can up and go anywhere without losing any exposure to their customer base.
The burger joint has a number of suppliers, many of whom will deliver on a daily basis. A break in that supply chain could mess with sales for a day. The software developer relies on less critical suppliers, and a failure is more inconvenient than an existential threat.
The burger joint is able to find and train staff quite easily. If the software developer needs another developer, it is a bit of a challenge. Developers are specific to platforms, languages, and experience. And they are expensive. They are difficult to find.
Where the burger joint is exposed to supplier performance and works off a high infrastructure fixed cost, the software company is chilled about suppliers and infrastructure.
The software developer sweats bullets over their staff redundancy, while the burger joint may find the loss of a griller irritating and the number of waiters inconsequential.
Potential purchasers of each company will be drawn from different backgrounds. There will be many possible purchasers for the burgers, while there will be few for the software. But we know both make the same profits. People will still buy burgers in 10 years. Unless the software is improved and developed continuously, it will be redundant in 10 years.
These are different businesses which should not be priced on the same formulas because every business has a different story.
What is my unprofitable business worth?
Buying gold improves your security in troubled political and economic times. The transaction has a price to add value to your life. That value is a last resort store of wealth. And there is value in future growth. But it will never pay you a dividend because gold does not generate profits.
The only value in gold is in the security it offers. And perhaps someone will pay you more for it someday. Bitcoin also makes no profits.
The price of Bitcoin is volatile, even in a single day. But Bitcoin still provides the same utility as it did last year, and even 5 years ago. It is still a means for universal autonomy. We can still trade it around the world with as much ease as before: when it was changing hands at $18,000, and at $4,000. The value of Bitcoin has not changed as wildly as its price in the last two years.
Neither of these two assets are businesses, though. There are problems with unprofitable businesses:
- They incur debts.
- "Unprofitable" is a hair's breadth away from "loss making".
- Unlike gold and bitcoin, businesses cannot be sold in a moment.
- Unsustainable loss-making businesses have a tendency of suddenly becoming worthless.
This should not suggest that unprofitable businesses should have no value, despite ZERO times ANYTHING AT ALL still being ZERO.
Behind every business valuation, and therefore what your business is worth to you, is a story.
- What happened in the years leading up the most recent results?
- What are the forecast earnings, and how reliable is the forecast?
- What threats and opportunities affect the future?
- What were the strengths and weaknesses which affected the recent results?
It is the story which informs the valuation, and therefore what it is worth to you, and what a price for the business is likely to be.
So really: what is my business worth?
The value of a business is an expression of what the owner currently gets out of it, and what they will get out of it in the future. They can sit tight and wait for those future profits, and still own the business. Or they can offer the business to another person at a discount to those future cash flows. That is the essence of discounted cash flow valuation.
The key to valuation today, based on what you will receive in future times, is the risk that those cash flows will not happen.
As a business owner you know the ins and outs of your business.
- You know how to deal with its creditors.
- You know how to twist the screws to get its debtors to pay on time.
- You have a good understanding of how the inventory cycle works.
- You have been down a road with your staff members.
- You have a deep understanding of what competitors are up to.
- You know what marketing efforts have worked in the past.
- You know about the wasted money on marketing failures. (You won't do that again.)
So to you the risk in the business is small. And if you were to buy your own business, you would be happy to take it at a very small discount to its future cash flows. You don't see so much unmitigated risk.
By contrast, someone looking to buy your business has a lot of uncertainty. Their learning curve will be steep, for one thing. And as the uncertain buyer imagines more risks, of course their value discount is going to be higher. And if a seller says from the first meeting that he will only be around for one month... Well then the perceived risk is even higher. (Pro tip: if you intend to sell your business in the future this is very important.)
There is a disconnect between "willing buyer and a willing seller" doctrine and value. As much as you disclose "all pertinent information". And as willing as the parties may be. No matter how much funding is available. The risk to the buyer is much higher in the raw and even higher in their own perception. There is no getting away from it.
So while the seller tries to convince the buyer of the safety and the prospects, they stop talking about value and move into the realm of price.
Your job as a business owner (who will exit someday) is to learn how to sell a business so you reduce risk to your buyer. Your efforts will gain you a smaller price-to-value discount. In other words - your selling price will be closer to your own perception of value. And then you can have a more meaningful discussion about "what's my business worth?"