After years of hard work building a successful small business, you may decide that the best way to secure your future and that of your family is to sell your business.   However, how do you determine what is a fair price?

According to the IRS, the “Fair Market Value” is the price at which the business would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the later is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.

In other words, what is the price an informed stranger would consider fair under all of the circumstances?   Rather then leaving this entirely at the discretion of that stranger, it would be wise for the potential seller to have the value of the business determined before the business is put on the market for sale.   In order to determine the fair market value of your business, you will usually need to engage the services of an accountant or other qualified professional to appraise the business.

The value of any business is, generally, determined by placing a value on several key components.

First, is the value as determined from the business operations.   Generally, the primary source of value in a business is based on the net profit, being the earnings of the business operations less the cash needed for operating expenses.   By taking the adjusted or net operating revenue from the business, the value of future, anticipated revenue can be determined.   The value is usually computed by multiplying the anticipated, future, annual revenue by a factor appropriate for that type of business.   For example, if the annual, net revenue is $500,000.00, the value might be $1,500,000.00 or three times the annual revenue.*

Second, in addition to its operating revenue, many businesses also have other sources of income.   These sources may include rents, licensing fees or interest on investments.   These cash flows have value; however, they are not as valuable as the operating income of the business.

Third, any cash reserves in excess of what is considered necessary to fund working capital also adds value to the business.

Fourth, fixed assets such as buildings, inventory and equipment will be assigned a value.

Upon an analysis of the above factors, it is possible to arrive at a fairly accurate assessment of the value of your business on the open market.

Of course, there are also intangible factors, such as good will, name recognition, location, and dominance in your marketplace that may enhance the value of your business.

Ultimately, the sale value of your business, at any given time, is the highest price at which someone is willing to pay you.

* Some experts would argue that you should use a multiple of the gross annual income rather than the net income.