What’s my sweat equity worth? I’m thinking about selling the business and wondering what it might be worth. My family and I have invested a lot of time, energy, and hard work building our business. We’re still a few years away from selling out. But if something were to happen and we had to get out quickly, or if a good offer came along, I want to know what the business is worth. Suggestions?
Thoughts of the Day: With sweat equity, there are several ways to get a ballpark value. Working backward from what you need is always a good idea if you have the time left to do so. Get an estimate of value now so you know what gaps you have to fill. Have a rapid action plan ready in case of emergency.
Sweat equity is generally not monetary
Privately-held businesses are financially nearly invisible. However, they make up 99 percent of all businesses operating in the U.S. Compare the number of pages devoted to public and private companies of any major newspaper. Diverse businesses, without standards for reporting other than tax returns, are difficult to compare.
Is one company performing better than another? What defines better? And yet, there is a common thread. All businesses eventually do get valued when they’re sold. Unfortunately, even these transactions are opaque as consulting or employment contracts displace share value, and wrap-up of assets and liabilities get mixed into personal tax returns.
Three common methods of valuation are, first, net asset, what’s left after paying off debts? Second, income, also known as discounted future benefit from likely cash flow. The third method is market. What have other businesses gone for?
How much value is added to a business
Comparing values may show the advantages of one method over another. Sweat equity is a great way to build up a business when you’re on a tight budget. When considering market value, focus on multiples — things that can have a multiplier effect to get top dollars such as strong customer list, strong product or service, lots of expertise, patents, production skill, great brand, golden handcuffs on key employees, turnkey operation and a list of potential buyers who know and like what your company has.
Be prepared to wade through terms like fair market value, cap rates, intended use, terminal value, competitive forces, business risk, assumptions, and limiting conditions. The American Institute of CPAs website has a highly detailed description of business valuation factors. Consider hiring a business broker or valuation expert who has data and expertise. Keep your eye on the trends of the overall market relative to your business, to gauge when might be the best and least advantageous times to sell.
Working backward from what you need is always a good idea if you have the time left to do so.
Recognition of contribution
Given that you’re not yet ready to retire, figure out your retirement and legacy goals now. Sweat equity is a commom factor among small businesses. Add up your other assets: house, Social Security, and retirement funds. Figure out how much more is needed to meet your goals, then decide what has to happen with your business to fill the gap.
Periodically get an estimate of what the business is worth. Use that value as a gauge of the business’s overall progress. Remember, the single biggest gauge of value is the ability to make a profit as demonstrated on annual tax returns. Don’t sell the business short by driving to zero profit — zero equity growth each year — just to avoid paying some taxes.
Have a rapid action plan ready in case of emergency. Think about what to do if something were to happen. A written plan will help everyone stay on point with the business. Who would immediately step in to keep things going? Is the sale the logical next step? Who would help you sell the business? When was the last valuation done? What’s been done to protect the business’ value? What if something should happen to you?
Looking for a good book?
Try “Valuing a Business, 5th Edition, The Analysis and Appraisal of Closely Held Companies,” by Shannon P. Pratt and Alina V. Niculita.
