Whats the correct way to find the value of my business?

[CJC5151]

I started my small custom furniture/cabinet shop 5 years ago.  I struggled as many start ups do mostly from lack of capital.  Right now im looking at taking on a partner. Which will generate immediate capital and allow me to do the things I know I need to do to move my business forward.  So my question would be, what is the best way for me to figure out the cash value of my business...thanks guys

[wdwerker]

I would look for a business consultant. Local chamber of commerce might be a good place to start. Maybe a lawyer that draws up partnership documents could help.

When a partnership works it's great, when it doesn't it's a nightmare! My brother went through hell for a couple of years to get rid of a partner and his business is still recovering. Choose carefully and cover your butt with paperwork and documentation .

Or look for a business loan and hire some talent, then you keep control.

[Vyrolan]

 Or look for a business loan...then you keep control.

 

This can actually work for a cabinet shop assuming you are decently equipped and don't owe on the equipment.   You can put up the machines and other gear as collateral.   Most small businesses have no chance at a loan because they have nothing but promises, hopes, and dreams.

[soonerdg]

^{Yes, definitly speak to a business concultand AND a lawyer about it.  Also consider, do you really want a partner?  Or do you want an investor?}

[Coop]

I am in the process right now of determining the value of my company. If you have a CPA, that's where I would start as mine has been very helpful.

Dave Ramsey says "that the only ship that doesn't float, is a partnership". Good luck and be careful.

[Eric.]

I'm no accountant, but I say figure out how much your assets are worth if you were to liquidate them right now, and add that to your NET income from last year (or the last fiscal year).  There's your value.  I would stay far, far away from partners unless it was someone you knew very, very well.

[Vyrolan]

...how much your assets are worth if you were to liquidate them right now, and add that to your NET income from last year...

 

Often you end up valuing small businesses based on gross revenue.  Most small businesses are going to report zero net income or even an operating loss for tax purposes (why pay business taxes on net profit when you can just buy a new piece of equipment instead and not have a profit).  You can try to figure out the value of the "total benefits of ownership" (people have their business pay for their truck because they use it for the business, etc, etc), but it's a convoluted mess.  

 

The simpler way then is to base it on gross revenue usually with some multiplier.  The multiplier is because to buy a business, you probably have to pay more than 1-years-worth of its earnings.   A common metric for publicly-traded companies is the price-to-earnings (PE) ratio.

 

In this particular case, I would probably say the value of his business is the total value of his assets (if he liquidated all of the machinery, wood supply, etc) plus 1.5 times a supplies-adjusted measure of gross revenue.   By supplies-adjusted measure, I mean all the money he was paid minus the cost of the wood (since that is a very clear and easy-to-quantify cost)...and only 1.5 times because he's a small one-man business and I wouldn't necessarily expect a woodworker to have a lot of repeat business (the latter being a gross generalization).

 

 

(Disclaimer: I am not an accountant either.  I do data work for a high frequency trading firm, manage my personal investments, and have invested in a couple of friends' small businesses.)

[Eric.]

You clearly know more about it than I do...at least you got the jargon down.    And all that probably looks great on some fancy papers, but in reality, if you can't show that a business is profitable, then you can't claim it has much value aside from its assets.  If the net profits are spent on new equipment at the end of the year, then that goes into the asset category.  Gross revenue means nothing...in my business I could generate a million dollars in gross revenue quite easily, yet still not put a single one of those dollars in my pocket at the end of the year.  It's all about how much cream is being scraped off the top.  If the OP is cranking out projects and shows a million dollars gross revenue, that looks great until you look at the expenses column and you see a million dollars there, too.  Or, conversely, to see a very small accumulation of expenses and a similarly small amount of revenue.  Either way, that's why this layman thought it would make more sense - to get a more realistic idea of actual value - to add assets to net profit.  But your way definitely sounds better.

[Vyrolan]

And all that probably looks great on some fancy papers, but in reality, if you can't show that a business is profitable, then you can't claim it has much value aside from its assets.

 

Yea it's a very convoluted subjective mess normally. =(   It's normally the business-owners that need the different approach because they are doing things to ensure the business as a whole shows essentially 0 profit.   It can be better to pay yourself a higher salary (or give a year-end bonus) rather than report a profit for the business for tax purposes.   Worse when the "business expenses" are essentially just indirect income for the owner (business pays for owner's truck, insurance, etc).  Those businesses may be successful and doing well, but there's no net profit at the end of the day.   The only people that care about net profit are stockholders and other investors.  If you're an employee, you don't want the business keeping profit...you want them paying more to employees with that profit.   A good growing business may report no profit because all the revenue coming in is being paid to employees or improving the business. 

 

Your point is true too though that you can have tons of revenue and it mean nothing.  A woodshop that spends 80% of its revenue on supplies (wood, hardware, etc) and the other 20% on payroll clearly isn't growing much (no new equipment, no marketing, etc).  But the woodshop that showed zero profit because it spent 25% of its revenue on adding tools to the shop to be able to do bigger projects or do them faster clearly is growing.  I'd invest in the business that spent 25% of its revenue growing over the one that just kept 25% in the business accounts as "profit" (or over the one that just paid out that extra 25% as a bonus to the owner =p).

 

Basically it's just really hard to value businesses. =p   For a bizzare example, look at Amazon...they're a 148-billion dollar company and they report close to zero (less than 1%) or even negative profit most quarters...and were negative for the year last year.  Valuing businesses is utter madness. =p

[Vyrolan]

All that being said, the first question I would ask is why do you want to sell part of your business?  If you have a good business and just need more money to buy equipment, a loan is always better than giving up your equity.   if your business is not making money, taking on an investor or buying more equipment rarely solves the problem.  If that is the case, try to find a mentor who can help you understand why you are not making money.

 

Great advice here...well said Mike.

 

 

I know getting a loan is difficult, but finding an investor or partner might not be any easier, and in fact might be a whole lot more difficult. 

 

Finding an investor can be nigh impossible depending on your restrictions...and it can easily come with a lot more baggage that you realize.  A loan is far simpler...they don't care as long as you pay.  An investor may want more insight/control in the business, try to influence/decide what projects to do or prices to charge, or whatever.   That can quickly become a nightmare.

[CJC5151]

Thank you everyone for all your insite....you have sure given me a lot to digest.  I started this business on my own with 0 outside investors, other then my wife I guess.  I have worked my butt off for the past 5 years to build the company and it has been a rough road but we are just now starting to have some success.   But I have hit a wall.  When I started it was fine to wear the pants of salesperson, project manager, secretary, financial manager, designer, craftsman, and installer.  The problem is that I have enough business now that I cant do all these things anymore.  Its killing my production and making it hard to complete deadlines which I take very seriously. I know it sounds like I just need to hire help, but ive tried that and it has been a disaster.  Finding someone qualified to build furniture is impossible now a days and the training is so intense that I still have to be in the shop with the employee for so long that im not actually of getting the benefit of having someone producing a custom table I designed while im out on a bid or in the office drawing or whatever I need to do.  That is why I was leaning toward an investor/partner.  I want someone else involved that can not only help with the everyday tasks in the shop/office but that is invested in the outcome and wellbeing of the business.  I have some things I want to do in my business such as launching a furniture "Line" that ive designed and need to develop a large amount of capital to do so.  up to this point I have been creating one of pieces and it has been great but I want to compliment that with a line that can be manufactured with the same quality of all my stuff but when I introduce repeatability, I know I can drastically cut my production costs.  

 

just wanted you all who have offered so much great advise to understand where I was coming from

 

thanks guys

[wdwerker]

I would think junior partner and a bank loan separately in that case. Or maybe look at it as a merger? Look at other shops like yours in the area?

[Vyrolan]

Finding someone qualified to build furniture is impossible now a days and the training is so intense that I still have to be in the shop with the employee for so long that im not actually of getting the benefit of having someone producing a custom table I designed while im out on a bid or in the office drawing or whatever I need to do.

 

IMHO...  Don't hire the skill...you're the skill.  Hire for the rest...someone could handle the office stuff (marketing, invoices, payments, etc) and free up a lot of time.  Also like Steve mentioned with a junior partner...hire someone for the shop that wants to learn but at first they just do basics like milling the rough lumber or parts of the sanding.  Installation could also be a more junior job (I know a great custom cabinet guy here in Chicagoland does that where he has a junior guy that started out in the shop doing really basic stuff and has worked his way up to basically taking the lead on all the installations...it was cool chatting with him to hear about his progression through the business).   They're basically like an apprentice...which is a forgotten concept but can be a great arrangement and mutually beneficial.

[jHop]

I was going to pipe up with some information, but Mike has not only beaten me to the timing but the quality as well.  One thing to do if you are serious about getting a partner (even a silent partner) is to get some legal help.  You will want to clearly define the areas of control that the potential partner has, and make sure you maintain ownership of the company.  It does you no good to split it 50/50 if, in six months, he's going to wreck the business, or pull the profits out of it so you can't break even.

 

If you get a silent partner, clearly define what their contributions will be (usually money), and what sort of schedule you have for repaying them for their kindness.  Also consider adding a buy-out clause to any contract you draw up for a partner.  If you become more successful in 6 months than you figured, and you are now saddled with a partner that's holding you back, you cannot grow like you want.

 

Alternatively, you can consider creating an LLC to partner with a partnership or cabinet shop (or other existing business) to grow your business that way.  LLCs get more protection, have easier times of being dissolved, and can be entered into by pretty much anybody.

 

Lastly, consider needs you have that you can hire people for.  If you need someone to man the sales floor, for example, hire them.  You are hiring them for their expertise, not their companionship.  If your goals are hit, you can reward them with some part ownership of the company.  (Be sure to tell them this before-hand, not surprise them as a Holiday Bonus.)  If you do reward ownership rights, again you will need to make sure you retain control.  Giving away 10 percent to your "talent" employees and splitting control of the company 50/40 with a partner still leaves you vulnerable if the talent takes the partner's side.

[CJC5151]

thanks guys...I think im on the right track.  I used the term partner loosely.  This person is making a capital contribution (cash) to the company.  he will be in charge of the office work, billing ect which will intern free me up somemore in the shop.  he will also be in the shop learning.  He has a skill set but still has a way to go, but he knows his way around the tools and wants to learn.  we are starting a llc and signing a buy out agreement.  talking to other businesses and lawyers I have found that who owns what percentage isn't really important if you have a buy out agreement since that is really the only time it will come into play.  I will untimately be the final decision maker. 

 

I do have a question about an llc in Indiana.   from what I understand, an llc is popular because of the fact that its only taked once with pass thru taxation similar to a sole prepriatership.  does that change any due to the fact that we will both be owners.  does a llp make more sense? can I even do an llp? ive seen that llp's are for lawyers and doctors in some states?

[CJC5151]

sorry for the terrible spelling, meant to spell check....lol

[jHop]

If I remember correctly, the only time you get taxed more than once on profit/ income is with a corporation.  LLCs (at least in my state) only tax the money once.  How your state does it might be different, so I'd take my statement with a grain of salt.  (Remembering that nothing in government goes unpunished... or at least that's the perception.)

[wtnhighlander]

If I remember correctly, the only time you get taxed more than once on profit/ income is with a corporation. LLCs (at least in my state) only tax the money once. How your state does it might be different, so I'd take my statement with a grain of salt. (Remembering that nothing in government goes unpunished... or at least that's the perception.)

I don't know about where you are, but where I live, some governement takes a bite out of my money when I receive it AND when I spend it. And sometimes, just 'because'....

[Eric.]

Corporations get taxed twice because they have shareholders who are payed dividends, and those dividends are taxed as income for individuals after the corporation's profits are taxed.  A small business without shareholders shouldn't be paying taxes on anything more than once, regardless of its structure.  If you are, you need a new accountant.

[Vyrolan]

LLC is fine with the two of you as owners...that is however where the percentage of ownership or the details of the LLC matter because you'll be passing the tax on to the two of you according to those numbers.   The LLC will have to produce K-1 forms for each of you that indicate how much income you have via ownership of the business, and those have to be filed with your personal income tax.   The LLC structure will work for you until the company grows to the point you don't care...I think you can have up to like 100 people in the partnership and still be just an LLC.

[dwacker]

I won't offer up any advice but I will leave you with some thoughts to ponder and confuse.

 

First owning a "business" is the biggest misconception and problem that folks just starting out run into.

 

You do NOT own a business, you conduct business. Business is an activity.

You own a company. A company is sort of an artificial entity it lives with or without you.

 

Are you a guy doing business or conducting business activities or do you own a company. If you die tomorrow does the activity stop? Before you even think about a valuation you need to have a company. You cannot place a value on a single person or their future earnings, you can only valuate their liquid assets and debts.

 

Think long and hard before adding a partner.

[Firehawk]

I won't offer up any advice but I will leave you with some thoughts to ponder and confuse.

 

First owning a "business" is the biggest misconception and problem that folks just starting out run into.

 

You do NOT own a business, you conduct business. Business is an activity.

You own a company. A company is sort of an artificial entity it lives with or without you.

 

Are you a guy doing business or conducting business activities or do you own a company. If you die tomorrow does the activity stop? Before you even think about a valuation you need to have a company. You cannot place a value on a single person or their future earnings, you can only valuate their liquid assets and debts.

 

Think long and hard before adding a partner.

Welcome back - PB!