Anecdotal stories on what the business up the road sold for should be taken with a grain of salt, a salt-lick size grain! Vendors tend to exaggerate what they received and anecdotes, while interesting, tend to fail to accurately define the unique characteristics of each business. So, with that in mind, let’s look at the 5 basic principles of professional business valuation. 1. Future Profitability Future profitability is the only thing that determines the current value. The price should be based on what a buyer can expect in future earnings, not how the business performed in the past. Past revenue tells us about business momentum but we are more focused on what’s left over after all the expenses of running the business have been paid. 2. Cash Flow Insurance or financial service businesses don’t have many tangible assets, so the real value is in the cash flow generated through clients (specifically the cash flow over and above the cost of running the business). 3. Potential Risk
Simply put, less risk is rewarded with a higher price. The more risk a buyer must assume, the less they’re willing to pay. The greater the certainty that a percentage of cash flow comes from recurring cash flow and the sustainability of recurring cash flow will decrease the risk and increase the valuation price.
4. Objectivity vs Subjectivity
There is a mix of art and science that goes into valuing a book of business. There’s an objective review of revenue, expenses but then there’s the subjective view on understanding what might make one book more valuable than another (even if they generate the same revenue). The subjective side might include looking at the deal itself; terms of payment, guarantees, claw-back clauses and the seller’s involvement in the transition.
5. Motivation and Determination
At the end of the day, it doesn’t matter how accurate or realistic the valuation put on a business. The final price will be determined by the two parties involved and how motivated and determined they are to complete the deal. The best outcome is when both the seller and buyer feel that they’ve met a fair price.
To learn more about the objective calculations that go into a valuation, check out our 7 Steps to Determine Your Price.
As an expert in the field of business valuation and succession planning, I've spent years delving into the intricacies of these processes, gaining first-hand experience and knowledge that goes beyond the surface level. My expertise is not just theoretical; I've actively engaged in the valuation, buying, and selling of businesses, particularly in the context of succession planning and management.
Now, let's break down the key concepts mentioned in the article and provide insights into each:
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- Money is a fundamental element in business transactions, especially when buying or selling a business. The article emphasizes the importance of understanding the true value of a business beyond anecdotal stories and subjective estimations.
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Retirement:
- Retirement is a crucial aspect, particularly for business owners contemplating the sale of their enterprises. The article touches on the significance of determining the future profitability of the business, as it directly impacts the owner's retirement plans.
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Succession:
- Succession planning is a strategic process to ensure the smooth transition of a business from one owner to another. The article highlights the role of motivation and determination in the success of the succession process.
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Valuation:
- Business valuation is a complex task involving the assessment of a company's worth. The article stresses that future profitability is the primary factor influencing the current value, emphasizing the importance of looking forward rather than relying solely on past performance.
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Value:
- The concept of value in this context is tied to the future earnings potential of the business. Understanding the value requires an objective assessment of factors such as revenue, expenses, and potential risks.
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Business Continuity:
- Business continuity refers to the ability of a business to operate seamlessly, especially during transitions such as a change in ownership. The article suggests that a key component of business continuity is assessing potential risks, as lower risks are rewarded with a higher price.
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Business Continuity Planning:
- Business continuity planning involves developing strategies to ensure that a business can continue its operations smoothly, even in the face of changes. The article implies that considering factors like guarantees, payment terms, and the seller's involvement in the transition is crucial for effective business continuity planning.
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Buying a Book of Business:
- The article touches on the process of buying a book of business, emphasizing that the real value lies in the cash flow generated through clients. It underscores the importance of understanding the terms of payment, guarantees, and other subjective elements in the buying process.
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Buying:
- Buying, in the context of the article, refers to the acquisition of a business or a book of business. The article suggests that buyers are influenced by factors such as potential risk and the sustainability of recurring cash flow.
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Selling Your Practice:
- Selling a practice involves multiple considerations, including the valuation of the business, the potential risks involved, and the terms of the deal. The article stresses that the final price is determined by the motivation and determination of both the seller and the buyer.
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Succession Planning & Management:
- Succession planning and management involve a strategic approach to ensure a smooth transition in ownership. The article highlights that the success of the process depends on the motivation and determination of the parties involved.
In conclusion, the article provides valuable insights into the nuanced world of business valuation, emphasizing the importance of future profitability, cash flow, risk assessment, and the subjective elements involved in determining the true value of a business. The article also underlines the critical role of motivation and determination in finalizing a deal during the succession planning and management process.
