How to Maximize the Market-based Approach of Valuing Your Business?
How should you value your business as you explore its potential sale? There are several valid methods, but many potential sellers favor the comparisons found in the market-based approach.
With this method, you compare your business to similar businesses that have sold. Such evaluation can provide valuable insights about the kind of price your business would fetch in the current marketplace.
Below are three market-based factors that can help an owner focus on important measures of a business' value.
Transition Risk Index
The value of a business is greater if it can be easily transitioned to a buyer. To enhance the ability to transition your company, look at:
- Systems and processes that don't rely on a particular individual's skill or personality.
- Whether the transition or sale would be internal or external. If external, then what is the experience of the potential buyer?
- The demographics of the client base. How many will stay after a transition?
- The amount of transition time or consulting/training the seller and staff can give the buyer.
Cash Flow Quality Index
Cash flow considerations are highly related to the income approach of valuation, which is based on expected revenues and the risk associated with those revenues. Under the market-based approach, however, rather than looking at the quantitative factors, look at the qualitative.
A key factor here is the client base. It must be analyzed for both amounts of future sales, as well as the length of time current clients will remain once the sale is complete. Consider:
- What is the average revenue per client? Is it increasing or decreasing?
- Will this client base bring future clients, for example, family members and/or professional colleagues?
- Are referral and distribution channels transferable? Growing, recurring revenue is obviously preferable to shrinking and non-recurring revenue.
Market Demand Index
This final factor takes into account a variety of considerations about your company, including its size, geography and even the intangible of public status. Areas to focus on here include:
- Have some economies of scale been achieved?
- Has a positive brand or reputation been built?
- Is the business already located in a desirable location?
- Has the selling price for this type of business been rising or falling in the last one, three or five years?
- Is there third party financing available for these types of businesses?
As an owner, utilizing these three components of market-based business valuation will underscore your company's strengths, as well as illustrate areas which need work in order to improve its ultimate sales price.