COMMENT
How To Value Your Home Business

If you run your own small business, even if it's from home, there may come a time when you decide to call it a day. However, you don't want to throw away all you hard work spent in building up the venture because any business is always worth something. Consequently, selling it can be a sensible option. But how much is your small business worth?

Generally, there are three ways to determine the fair value of a small, privately-owned business. The most common approach is an income method, which values the business based on a multiple of its future profits after tax. To find the fair market value, you divide the annual profit after tax by the capitalisation rate. (The capitalisation rate is the buyer's required rate of return less the annual profit growth of the business).

However, whist the calculations may seem deceptively simple, deciding on an appropriate capitalisation rate isn't! That's because the required rate of return is what rational investors (they are a rare breed) will expect in relation to the risk. Generally, a buyer will want a larger return when buying a risky venture and a lower return if the business is quite predictable.

Not surprisingly, as a seller you will want use the lowest possible capitalisation rate. Mind you, a buyer will be doing the opposite. In the main, capitalisation rates for small businesses are unlikely to be lower than 20% to 25%. This implies a buyer will want to buy your business for around four to five times annual profits. This is obviously a lower multiple than larger businesses change hands for on the stock market. But then small businesses are usually a lot more dependent on their owners.

If your business has expensive assets, then it may be better to value the business based on those instead. For instance, an apiarist may consider his prize bees and custom-made beehives to be worth considerably more than the profits made from selling honey to local shops. In this case, the income approach may not fully justify the value of the assets. Additionally, any contracts, albeit tacit, with local shops should be included as goodwill, which is another asset.

Finally, it's possible to value your venture using a market approach. For example, if you can find a similar business that has recently changed hands, then this may provide some useful pointers to the value of your own venture. However, for most small businesses, finding a comparable firm that has been sold is generally quite difficult.

In my view, the upshot of all this is the importance of maintaining good bookkeeping records. Not only is this important for tax purposes, but it's vital if you ever decide to sell you home business. A buyer will want to see reliable records, even if they may not have been audited by an accountant.

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