How to Determine the Value of a Business When One Partner Wants to Leave
Valuing a business can be tricky when one of the sellers is an owner who has put his blood, sweat and tears into the company and wants that sweat equity considered in the sale price. To help determine an objective value for a business, calculate its worth based on profit history and future projections, and factor in the capital you’ll need to continue operating.
The first step in determining the value or your business is to gather your financial data, including current and previous budgets, tax returns, bank statements and a current profit-and-loss statement and balance sheet. If possible, create a report that compares the performance of the business over the past three years. If one year shows a spike or severe drop in profits, analyze why and decide if these profits or losses should be included in your valuation.
The sale price of a business will depend primarily on profits. Once you can show a pattern of recent profits, you can estimate why these profits occurred and if it’s likely they will continue to accrue to the business at the same, higher or lower levels for the next several years. In addition to annual profits, look at your most recent six months to determine if they indicate any possible trends.
A departing owner will want assets such as trademarks, patents, equipment, inventory, cash on hand, investments, land, buildings and receivables included in the valuation. List all of the hard and soft assets and calculate their value. You might not assign a cash value to soft assets such as goodwill, grandfathered licenses or zoning, recipes or key employees, but you will want to include them in the sale, precluding the seller from taking or using them for a new business. If the seller has been a central asset to the business, consider having him sign a noncompete clause.
Even if you both agree on a value and selling price, you might not have enough money to run the business if you transfer a considerable amount of the business’s assets to the departing seller at one time. Determine the forward operating capital you will need and decide whether you need to pay the selling partner over time, instead of in a lump sum.
Using your financial data, work with your partner to predict your profits for the next several years. Discuss what the partner's departure will cost the business in terms of expertise or value. Consider two different profit scenarios if you can’t agree on one, with the sale price paid over time based on each scenario. This way, if the business does as well as the seller expected, he gets the sale price he wants based on those numbers. If the business doesn’t perform as well as expected, he might be willing to sell for less.
The risk in this approach is that future profitability might be the result of the remaining business owner’s efforts rather than the business's foundation. The buyer might also drive the business into the ground, leaving the seller with little or nothing if he agrees to payment over a number of years.
A common method of determining the value of a business is to multiply the anticipated annual profits by a number of years. For example, if you anticipate a profit or $200,000 per year for at least the next three years, the value of the business would be $600,000. This number can vary from three to eight years, depending on how long the business has been operating, how sure the buyer is that the business will continue to perform and other factors.
Industry standards for multipliers is largely a myth, as every business is different based on its managers, location, recent competition and other factors. Work with a business broker who represents both parties to determine a realistic multiplier. Once you agree on the value of the business, cut that number in half, with 50 percent going to the departing owner and 50 percent staying with the remaining owner.