2 Methods of Sweat Equity Valuation

The premise upon which most businesses operate is that of profitability. Products are manufactured by modifying the properties of raw materials such that their value increases above the commodity value of the raw inputs. In a similar fashion, businesses of all kinds are created, improved and sold for a profit. For example, if the owners of a company that provides language translation services decide to retire, rather than closing the business they can sell business language translation services as a package. Likewise, if the owners of a manufacturing concern want to start a different company making some other product, they can sell their manufacturing operation to new owners.

There are a few unique twists in these transactions. The valuation of a business requires a careful review of its performance, assets and liabilities. Business owners often invest more than just tangible assets into their company. The efforts of a proprietor to develop and maintain a positive reputation and build a customer base represent value. Arriving at an acceptable value for “sweat equity” can be a complex task.

Comparable Business Value

When evaluating the effort and expertise invested by owners and employees one good reference point is the sale of other similar businesses. After accounting for and deducting the cash value of tangible assets from a sales price, the remainder is an indication of the sweat equity’s cash equivalency.

Past and Future Earnings Value

Previous earnings are a measurable indicator of a company’s worth. By factoring in market conditions, predictions about earnings and profits provide another useful valuation reference point. There are industry-specific methods that use profits and earnings multipliers to arrive at a fair market value for a business. Once a total value is established, determining intangible investments is again accomplished by subtracting the company’s hard assets’ worth.

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Transactions involving businesses vary in complexity depending on the general economic climate, size and type of the enterprise and demand within an industry. Successful negotiations hinge on accounting for both the tangible and intangible components of a company’s worth.