How much is any business worth? How much is your business worth? the simple answer is that a business is worth what the market will pay for it. this is also the legal definition of value.
There are actually two ways to think about Business Value, and how to maximize value. these two ways are:
1. What creates value?
2. How is value formally assessed?
Value for any asset is determined through supply & demand. If supply is abundant value is low. if supply is limited – value is increased. But, we can create demand, and this is an important way to think about improving the value of your business in the market – by increasing demand for that business. How do you do that? We will look at that in a later section.
When considering how the “formal value” of a business is assessed you need to start thinking about what kind of return a buyer expects from their investment. It is usual for buyers to want to receive a return of between 25% and 50% on the investment. So if a business is earning $100,000 per year, it should sell for between $200,000 (50% return) and $400,000 (25% return on investment). This is known as the capitalization rate.
What determines the expected return? It is risk. so when looking at the value of your business, the next step is to consider the risk. If a business is considered to be really “safe” and relatively risk free, a lower return of investment is accepted by buyers. An example of this kind of business is a Post office. these are considered to be safe, have government support, an exclusive area, no competition, and only trade for five days. Therefore, these businesses have a return of around 20% (or five times earnings).
A “riskier” type of business is a café. These are considered to be less “safe” and therefore a greater risk applies. a café buyer will expect a 50% return on investment (or two times earnings).
So if the Post office and café are both earning $100,000 per year, the café will sell for $200,000 (50% return) and the Post Office will sell for $500,000 (20% return).