Business Valuation Methods: Part 3

3. Market Value Approaches

Market value approaches to business valuation attempt to establish the value of your business by comparing your business to similar businesses that have recently sold. Obviously, this method is only going to work well if there are a sufficient number of similar businesses to compare.

Assigning a value to a sole proprietorship based on market value is particularly difficult. By definition,​ sole proprietorships are individually owned so attempting to find public information on prior sales of like businesses is not an easy task.

Although the Earning Value Approach is the most popular business valuation method, for most businesses, some combination of business valuation methods will be the fairest way to set a selling price.

Non-Competition Clauses Can Affect Valuation

Non-competition clauses are frequently included in agreements for the sale of a business, particularly in cases where goodwill forms a significant part of the valuation. No one wants to purchase a business on the assumption that current customers will continue to patronize the business only to have the previous owner immediately join a competitor or open a similar business in the same area.

Non-competition clauses typically contain restrictions such as:

  • Forbidding the seller from opening up a competing business in the same geographical area
  • Attaching a time limit to competing activity – for example the buyer may request that the seller not engage in direct competition for a period of five years

Non-competition agreements can be a thorny legal issue and are often the subject of court cases between buyers and sellers after a business is sold. From a legal standpoint, to be enforceable the restrictions placed in a non-competition clause must be clearly defined and ‘reasonable’. Non-competition covenants can be nullified by the courts if it is determined that enforcement places overly broad and/or unreasonable restrictions on the seller’s ability to continue his/her trade and earn a living. Non-competition clauses should be reviewed by the legal representatives of the buyer and seller prior to the sale of the business.

What About Franchise Businesses?

Franchise agreements generally define how a franchise can be sold, and these vary by franchise vendor — check your franchise contract. Some contracts stipulate that the franchisors will buy back your franchise directly for a fixed price. Others provide assistance with valuation and locating a buyer, as it is in their best interest to make sure that the business continues uninterrupted.

The Best Choice May Be a Combination

Although the Earning Value Approach is the most popular business valuation method, for most businesses, some combination of business valuation methods will be the fairest way to set a selling price. The first step is to hire a professional Business Valuator; he or she will be able to advise you on the best method or methods to use to set your price so you can successfully sell your business.

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