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The purpose of this article is to help business owners understand and apply different ways to value a business. The emphasis is on valuation at the time of sale, and if seller financing is provided, when and if the note is sold.

While these two events are significant, they still represent snapshots in time relative to the length of business ownership. So I will include ideas to implement during business ownership, that help prepare for a future sale.

For starters I am referencing an Inc. Magazine special report from January 2006 titled “The Definitive Valuation Guide.”^[2] A point of emphasis in both that article and what I am sharing here, is that there are many ways to value a business, and many factors that affect the value derived. It will help business owners to at least become more acquainted with the possibilities.

When a business is sold, typically assets are sold as a mass assemblage as part of a going concern. While an investor buying a business note will consider this value, the business may no longer be a going concern at that time.

So the business note investor will also consider these values:

• Value of a mass assemblage of assets sold for a business not currently operating.
• Value of assets sold piecemeal in an orderly disposition.
• Value of assets sold piecemeal in a forced liquidation.

In more formal terminology, these four options are referred to as “premise of value.” So the most appropriate premise of value must be chosen before considering the various valuation methods.

The last three options above, will each be less in value than the mass assemblage of assets sold as part of a going concern. And they remain a future consideration for the note investor, even if a business note is being purchased, when the business backing it is still a going concern.

But what about differing values when the business is operating under normal conditions. We know that “normal conditions” have plenty of ups and downs.

For the Inc. Magazine article mentioned above, they asked two appraisers to place a value on three different companies. These highly credentialed appraisers had different approaches, but followed similar steps. They interviewed the entrepreneurs, researched each industry and reviewed years of financial statements. The chart below shows the results.

Inc. Magazine Data ^[3]

Business Name	Entrepreneur's Gut Value	Appraiser A	Appraiser B
Busines Name:Vivid Sky	Entrepreneur's Gut Value:$2.5million-$4million	Appraiser A:$5million	Appraiser B:$0(or $1.9million if seed financing is secured)
Busines Name:Mistrial Software	Entrepreneur's Gut Value:$25million-$35million	Appraiser A:$30million	Appraiser B:$14million
Busines Name:Infinite Conferencing	Entrepreneur's Gut Value:$15million	Appraiser A:$10million	Appraiser B:$10.5million

Appraiser A had more of an entrepreneurial background, which in two examples led to much higher values. This illustrates some of the valuation extremes that are possible. For the smaller business which is more typically involved in selling a business note, there are many more variables to consider. And a business note investor buys the note, not a potential gain if the business itself becomes a huge success.

The more profitable a business is as a going-concern, the higher is it’s value at that time. On paper this will produce more favorable financial statements. This should lead to a higher price when the business is sold. Of course the business owner will then expect this process to lead to a higher price if the note is sold. While that is the goal, there are many variables affecting value at each stage.

Accounting Versus Economics

While operating your business chances are you will be using an accountant, which I encourage. Part of the accountant’s background is in cost accounting. In years past cost accounting evolved from the use of cost data to produce financial statements, to use in managerial decision making.

Contemporary Cost Accounting And Control ^[4] by George J. Benston includes a series of readings on this topic. One of those readings is titled “Approaches to Pricing: Economist Versus Accountant” by Alfred R. Oxenfeldt and William T. Baxter. Here is some of what they offer:

“It is generally true that the cost accountant fails to state his assumptions about the firm’s aims and pays scant attention to demand; he collects cost data and arrives at price by manipulating these. The economist, on the other hand, starts by assuming that the firm is trying to maximize something, for example, profit; he then shows how the firm should study demand as well as cost in an attempt to find the maximum output level.”

“A good example of the need to modify prices found by means of a costing margin occurs when a firm sells many different products to the same customer. Such firms may be said to sell a “line of products.” A new customer means sales of many products; a lost customer means lost sales of many products.”

“Importance of demand. Our review of the forces at stake has emphasized the supreme importance of demand. Though this force is hard to gauge, the pricer’s success must in the long run depend on his flair for assessment.

Part of his problem stems from the effect that frequent price changes may have in the long run on customer relations….Does the firm feel that isolated price concessions will involve a serious handicap in the future? The top executive might even be called upon to set a figure that measures the size of the handicap….”

My thoughts:

• It should help you if you can steer your accountant to the economist’s viewpoint, and by maintaining that approach throughout your business.
• What happens if you sell a “line of products” and lose a customer just before you sell your business? What about the concerns a business note buyer has about this happening in the future? The better success you have dealing with such matters while operating your business, and the better you can document it, should help increase the value of your business going forward.
• How well do you respond to fluctuations in demand and related price changes? Do you have a plan for handling periodic price concessions? How will you convey this to a prospective buyer?

Increasing The Value OF Your Business

To develop these ideas further, what can you do while running your business that will increase its value? How can you do this in such a way that will increase going concern profitability, value at the time of sale and the price you will get when you sell your business note or part of it?

For an example of one detailed answer, I have included the following link: Business Reference Guide Online Sample Search^[5]. This thirty-two page PDF also serves as an advertisement for the purchase or the subscription to the full guide (I am not an affiliate). It is referred to as the essential guide to pricing businesses.

The full Business Reference Guide covers over 600 types of businesses. The Online Sample covers the restaurant business and provides substantial details of the factors considered in placing a value on a restaurant. For other business types though, this tool offers many ideas that you can use to evaluate your business, and develop into plans for greater profitability.

While the Online Sample uses the restaurant business as the industry covered in this tool, I realize the added concerns restaurant owners face currently during Covid-19. While that issue is not dealt with in this article, rare instances such as this along with natural disasters are additional factors that compound business valuation for business sellers, buyers and business note investors.

Did you notice the following comment in the Business Reference Guide Online Sample Search? In reference to business sellers they state: “Your CPA's valuation of the business is almost always three to four times higher than what the restaurant will sell for in the open market.” While this is taken out of context, it’s not the only valuation news you may not like. And for those new to the process, keep in mind that business notes are sold at a discount.

So then I can’t emphasize enough that while you’re working long and hard to be profitable, learn more about what you can do differently.

Part of my purpose in including this sample guide is to get you thinking of the many possible valuation concepts that may help you now and in the future. So let’s focus now on valuation as you prepare for the sale of your business, and on the sale of a business note.

The better a business note seller can demonstrate the value of their business, the better price I can get for you from a note investor. The better your documentation, the more convincing a case you can make. The same applies to the price you can sell your business for. So it’s best to prepare for the sale well in advance.

From the perspective of a note investor considering buying your note, the key question is “how did you determine the sale price of your business?”

I’ve alluded to the existence of many valuation methods. My research finds a variety of views of what to include in an article on this topic. For example an article in Investopedia.com titled “How To Value A Company,” under the heading methods of evaluation, describes Market Capitalization, Times Revenue Method, Discounted Cash Flow (DCF) Method, Book Value and Liquidation Value.

Here is what they say next: “This is by no means an exhaustive list of the business valuation methods in use today. Other methods include replacement value, breakup value, asset-based valuation and still many more.”

Yes there are more, along with plenty of related terminology. People may have a general understanding of value that is vague. Their definition of related terms can be fuzzy. And depending on their role in this process, emotions will have varying impacts.

Depending on your background and level of interest, this article in nav.com titled “Small Business Valuation Methods: How to Value a Small Business”^[6] provides a good introductory overview.

By sharing all of the above with you, my hope is to stimulate your thinking. While you’re busy running your business, can you spend at least a little more time maximizing business valuation? It will help you increase profits and bring you a higher price when you sell your business.

Values Of Interest To Business Note Investors

So let’s say you have sold your business and you want to sell your business note or part of it. The work you have done up to that point in time, will have the greatest impact on increasing the value of your note. The details of your note matter a lot too. Then it’s back to the key question, how did you determine the sale price of your business? This goes well beyond which valuation method was used. The note investor needs to understand the details of the value you and your buyer placed on your business.

When a business is sold, whatever valuation method is used, the process produces a transaction value. Here is the definition of transaction value provided by the International Business Brokers Association (IBBA):

“The total of all consideration passed at any time between the buyer and seller for an ownership interest in a business enterprise and may include, but not be limited to, all remuneration for tangible and intangible assets such as furniture, equipment, supplies, inventory, working capital, noncompetition agreements, employment and/or consultation agreements, licenses, customer lists, franchise fees, assumed liabilities, stock options, stock or stock redemptions, real estate, leases, royalties earn-outs and future considerations.”

This definition addresses many of the specifics a note investor is interested in, no matter what valuation method was used. Since a true business note does not include real estate, what are the assets securing the note? Ideally, what are the hard assets securing the note that can be sold in the event that the note defaults?

A buyer of a business is receiving furniture, fixtures and equipment, along with anything else that can be touched. The other big category is goodwill, which is important from a note investor’s perspective. Here is the IBBA definition of goodwill:

1. Those elements of a business that cause customers to return in sufficient volume to generate profit in excess of a reasonable return on tangible assets.
2. That intangible asset that arises as a result of name, reputation, customer patronage, location, products and similar factors that have not been separately identified and/or valued but which generate economic benefits.

Keep in mind that there is both overlap and contrast in the perception of goodwill in common conversation, IRS regulations and Generally Accepted Accounting Principles (GAAP).

When a business is sold, the price paid beyond assets minus liabilities equals goodwill. So in common usage goodwill becomes a catchall category. Goodwill is often equated with intangible assets. But there are differences and it is important to distinguish them when selling a business note.

The problem the note buyer faces in the event of default, is that you can’t foreclose on goodwill. So it is important for the note seller to show the logical values that were assigned to intangible assets when the business was sold.

Goodwill is really a category of non-quantifiable assets such as customer loyalty and brand reputation.

Assets that are non-physical but identifiable are intangible assets. Some examples are technical documentation, customer lists, business contracts, automated databases, employment agreements, trade names, leasehold interests, patents and copyrights.

Patents, trade secrets and copyrights make up a category of intangible assets called intellectual property.

When selling a business note it will be important to have documentation of the values assigned to intangible assets as part of the sales price of the business. These intangible assets should provide measurable income to the business and enhance the value of other assets.

I mentioned transaction value above. Another concern the note investor deals with is the difference between the value of a transaction made on terms, and its cash equivalent value.

While providing seller financing has advantages for the business seller, much seller financing is provided because of the difficulty obtaining bank financing for small business sales. This can lead to compromises that produce a transaction value, greater than the cash equivalent value.

So this process is leading to the question “what is the investment value of a particular business note, in the view of different note investors?”

Since the business was sold on terms, an investor, similar to an appraiser, will compare the business note to some standard such as bank rates. While interest rates will vary over time, in general a bank will charge 2-3% over the prime rate for short-term business financing. Long-term rates will be higher. Even if bank financing could be obtained to purchase a small business, the rates would be even higher. This indicates that the perceived risk is even higher.

The business note investor will take all this into account. Of course there will be varying terms among notes, along with varying amounts and quality of collateral. Likewise the price an investor is willing to pay for a business note will vary accordingly.

Investors in business notes will quote different prices for the same note, based on varying opinions of future earning power of the business; based on the degree of risk of the business and the note payor, and based on the true worth of the note determined by many variables. By dealing with me as a note broker instead of a direct buyer, I can find the investor with the highest opinion of the value of your business note.

Conclusions

Here are some conclusions to implement:

• During the years you operate your business, take some time away to learn ways to do things differently, which will increase profits. You will increase the value of your business by doing so.
• Prepare years in advance to sell your business. Research other businesses in your industry that have sold, with a focus on what increases value.
• If you plan to offer seller financing when you sell your business, utilize some of the materials in this website to help you structure your note. Keep in mind how a note investor will look at the value of your business differently than the purchaser of your business.
• Complete documentation will really help you convey the value of your business. And a better understanding of business valuation will lead to better documentation.

Helpful Reading

What Is A Business Note

Do You Have A Seller Financed Business For Sale? - Part 1

Do You Have A Seller Financed Business For Sale? - Part 2

Make Your Business Notes Profitable.

Seller Finance Your Business

Do You Plan To Sell Your Business To Buy Another Business?