One of the biggest questions I get when talking to business sellers (and buyers) is "What is this business worth?" The answer is never easy, but let's discuss some of the approaches we take when we value a business - and I will discuss some recent research done on Canadian and US business transactions that show some revealing stats!

In general, there are three approaches to value a business - based on assets, based on income (cash flow), and based on market comparables. As I have said before, all three come in to play, but they are not additive - we typically want to look at all three methods before making a final determination of value, but we can't add the value derived from the income approach to the value of the assets.

The more comparable the asset, the easier it is to understand and apply market comparable approaches. The best example of this is residential real estate - my house is worth $150,000 because my neighbor just sold his for $150,000, and we have similar homes. Of course, no two homes are alike, so we adjust for certain factors: the extra bedroom is worth an additional $10,000, the smaller kitchen costs you $5,000 (these numbers are by way of example only - consult a real estate agent if you want your house appraised!)

Unfortunately, when you look at businesses, almost nothing is directly comparable - businesses differ based on location, revenue, costs, profitability, management, etc, etc.. That is why they are typically valued based either on income that the business generates or based on the sum of assets (equipment, inventory, etc.) that can be valued separately. Of course, valuing just the tangible assets typically ignores the "goodwill" of the business - the intangible value of the business that makes it worth buying or, for the seller, makes all the sweat equity real.

The valuation of goodwill is the tricky part. That is why we typically start by looking at the income the business generates to determine the overall value, and then compare that number to the sum total of all tangible assets to determine the goodwill component.

Recent Research

So much for theory - what do the numbers say? While it is always risky to use comparables for businesses, they do shed some light on the overall market. I was recently analyzing over 10,000 transactions of businesses across North America, and tried to isolate the "goodwill" component. What I found was quite instructive, especially for Canadian businesses. In general, everyone assumes Canadian businesses sell for less than US businesses. This is true - but only up to a point. The "multiples" of income that Canadian businesses get are very similar - on average - to those in the US, but the multiples relating to pure goodwill are lower - about 30% lower.

What does this mean? Canadian businesses are doing fine - but when they are looking to sell, they need to know how to maximize their goodwill. The business buying market is less robust here than in the US, where people are willing to pay more for the intangible aspect of a business. That is where we help - we help business owners maximize the value of their business both before they sell, and as they sell their business.