How to Value a Business: The Asset Approach

If your business has $400,000 worth of equipment sitting in the shop, then it's probably worth $400,000, right? Well, not exactly — and most of the time, it's probably worth a lot more than that.

Intro

This is Part 3 of my four-part series on business valuation. In Parts 1 and 2, we covered the Market Approach and the Income Approach. Today we're covering the Asset Approach — the simplest of all the valuation methods, but one that a lot of people misunderstand.

I'm Ed, a business broker and the founder of Sundance Financial. We help small business owners sell their companies all over the US.

This is going to be a shorter video because the asset approach is pretty basic, but let's get right into it.

The Asset Approach

The Asset Approach values your business based on the fair market value of the assets it owns to operate — that's things like your equipment, your vehicles, your inventory, and your receivables.

I'll be honest with you — I'm not a huge fan of using this valuation method for profitable operating businesses. And here's why.

What the Asset Approach is really measuring is the scrap value of the business. It's what you'd get if you stopped running the business entirely, shut down the doors, and sold everything off. But that ignores one of the most valuable things about your business — the fact that it's a "going concern." It's generating cash flow, it has customers, it has a reputation, a trained crew, and a brand that took you years and years to build.

The Market Approach and the Income Approach we covered in Parts 1 and 2 both, at their core, answer the question: how much is this operating business worth? The Asset Approach answers a slightly different question, which is more like: what could I get for the parts if I broke this business up?

And that's why it never really gives you the right number for a profitable operating business. But it's still worth digging into, and I'll explain why.

Worked Example

Let's go back to the landscaping company from Parts 1 and 2 — with SDE of $300,000 and a value of about $750,000.

Now, what does the Asset Approach say it's worth?

What we'd do in this case is add up the fair market value of every operating asset the business owns. That's things like the dump truck, the work trucks, the trailers, the Bobcat, the mini skid steer, the wood chipper, etc.

Operating Asset	FMV
Dump truck	$55,000
2 work trucks (F-250/F-350 class)	$70,000
2 trailers	$20,000
Bobcat compact track loader	$70,000
Mini skid steer	$45,000
Wood chipper	$35,000
Stump grinder	$20,000
Hand tools, chainsaws, blowers, climbing gear	$20,000
Inventory (mulch, parts, materials)	$15,000
Accounts receivable	$30,000
Operating cash	$20,000
Gross Operating Asset Value	~$400,000

So illustratively, adding all those up, the Asset Approach gives us a value of about $400,000 for the same business that the Market Approach would have valued at $750,000 and the Income Approach would have valued at $770,000.

So where's the gap?

Book Value Vs. Fair Market Value

Before I get into that, I wanted to add a quick technical note. When you go to do this exercise, you should not just pull the asset values off your tax return or your balance sheet. Those are what we call book values, and they're really just what you paid for the equipment minus the accumulated depreciation over the years of use.

For tax purposes, your $70,000 Bobcat might be depreciated down to $5,000 on the books — but it may not be worth that on the open market.

For the purpose of valuation using the Asset Approach, what you really want is fair market value — what a buyer would actually pay for that asset today. Equipment dealers, auction comps, and online marketplaces are all good sources to try to ascertain this value.

Goodwill — The Part You Can'T See

So coming back to the question — if the operating assets are worth $400,000 and the business is worth $750,000, where's the remaining $350,000 coming from?

Well, that gap has a name, and it's typically called goodwill.

Goodwill is an intangible asset that represents the brand, the reputation, the 40 years of word-of-mouth referrals, the repeat customer base, the trained crew, the systems, the established supply relationships. It's everything that makes the business a functioning enterprise as opposed to just a collection of operating assets.

You can't always see it on a balance sheet, but it's often one of the most valuable things that a business owns — and it's exactly what the Asset Approach tends to miss.

So Why Does The Asset Approach Still Matter?

Well, there are two reasons.

First, it sets the floor for your business. In general, you would rarely expect your business to sell for less than its tangible asset value. At that point, you'd be better off just selling the individual pieces of equipment as opposed to the business as a package.

Second, it's still the right method for some specific situations. That might be a situation where you're valuing a very asset-intensive business like a real estate holding company, or a situation where the business isn't generating any positive cash flow and is actually being valued for liquidation as opposed to being sold as a going concern.

But for a healthy, profitable small business, the Asset Approach should be thought of as more of your safety net — not the value of your business as a whole.

One Important Note On What You Take Home

There is one thing I do want to flag before we move on, because it trips up a lot of sellers.

The $400,000 of operating assets — and the $750,000 sale price, for that matter — is the value of the business. It's not actually the amount of money that you walk away with at closing.

Small business sales are almost always structured as cash-free, debt-free asset purchases. That means the buyer takes the operating assets, with the equipment and the working capital it needs to run — but any debt secured against those assets gets paid off at closing out of your proceeds.

So if you've got a $30,000 loan on one of your trucks, that loan gets paid off when the deal closes — but that comes out of your pocket. It's the same with any equipment financing, lines of credit, or any other business debt. What you take home is the sale price minus what you owe, and minus any taxes that you need to pay on the sale.

And this actually applies no matter what valuation method we use to get the price. Cash-free / debt-free is the standard for how small business deals are structured.

Tying It Together

Now before I let you go, I want to cover one concept that ties everything we've covered in this series together.

When we talk about the value of our business, we're typically referring to the value of the entire operating enterprise. That includes:

• The operating assets — things like your equipment and your vehicles
• The working capital — that's your accounts receivable, the cash you have on hand, and your inventory
• And critically, the goodwill — that's things like the brand, the customers, and other intangible assets relevant to the business

A buyer typically isn't just looking to buy your profit stream. They're looking to buy a complete, functioning business with everything it needs to operate from day one. A good broker should walk you through this clearly and early in the process — because the structure of a deal determines what's included, what's not, and what hits your bank account at the end of the day.

So that's the Asset Approach. Now in Part 4 — the final part of this series — I'm going to show you a method that most brokers won't walk you through, but that every sophisticated buyer is using. It's called the Returns Method, and it will completely change how you think about the asking price. I'll share a link here when it's live.

Now if you found this series useful, you can do me a favor and hit subscribe. And if you want to talk through your specific situation, I offer a free, no-obligation consultation — the link will be in the description below.

Again, I'm Ed from Sundance Financial, and I'll see you in Part 4.