Do you know what your business is worth today?
Lots of factors weigh in. Sales, profitability, and growth trends certainly do, but other factors, including the sustainability of current sales trends, the channels that customers use to access your business, the systems and processes that you use to operate the business, and even your role in the day-to-day operations of the company, can play a big part.
And, because your business doesn’t operate in isolation, you’ll need to understand the value of your business as it stands in the market. Your business’s performance, pool of competition, and ability to stack up against similar businesses sold to other buyers can also help you determine its true value.
Business brokers and valuation specialists can help you make sense of these numbers and find the right price to ask for your business.
After studying your unique set of factors, they’ll likely take one of the following three approaches to valuate your business:
Approach 1: Multiplier
The team tasked with valuating your business will study your earnings before interest, taxes, depreciation, and amortization (EBITDA) to calculate your net profitability. Then, they’ll assign a multiple (usually between 1 and 4) that’s based on the size of your business and the industry in which it operates.
Below, you’ll find a chart with the ranges of multiples many valuation specialists use for various kinds of businesses. Why use ranges? Ranges are used because the success of businesses within a specific field can vary.
For example, in an owner-dependent business, such as an independent restaurant or auto repair shop where the business is heavily dependent on the specialized skills or relationships of the current owner, valuation specialists may recommend a multiplier between 1 and 2, depending on the size and success of the business. A small, moderately successful business in this category that nets $100,000 a year may use a multiple of 1.5 and be priced at $150,000 (or $100,000 x 1.5), while a more established business that nets $500,000 may be priced using a larger multiple of 2, resulting in an asking price of $1 million (or, $500,000 x 2).
Other types of businesses use different ranges of multiples:
How can I earn a higher multiple for my business?
To earn a higher multiple, you’ll need to demonstrate the potential for a high return on investment (ROI) or make moves to lower the risks in your business.
You can achieve both objectives by offering proof of one or more of these elements:
- Predictable sales
- A stable pool of customers
- A high frequency of repeat sales
- Access to suppliers of critical inventory
- A pristine legal history
- Well-documented practices
- An established management team
- Solid potential for growth
But here is something to keep in mind: You can’t always get a valuation at the top end of your industry’s range. When your business is in distress, there are uncertainties in your market or customer base, or there are stalls in your business’s growth, your broker or valuation specialist may recommend a lower multiple.
Approach 2: Discounted Cash Flow
Some valuation experts prefer to valuate businesses by calculating their discounted cash flow (DCF). This method is based on the premise that the cash your business earns today is worth more than the cash it may earn in the future. With this in mind, your broker or valuation specialist will study your earnings and make projections about your future cash flows.
Future cash flows are projected 3-5 years into the future using a conservative rate of growth. Then, they’re discounted by the rate of return a new owner might attain by investing the cash flows in a risk-free investment vehicle (such as a U.S. Treasury bond) plus a discount rate for risk. This rate for risk is usually based on a business’s customer concentration, reliance on a small number of key employees, volatility in earnings, and threats of legal or regulatory concerns. The discount rate for risk may be as low as 20% for large businesses in markets that have moderate barriers to entry to as much as 50% for smaller businesses with minimal barriers to entry.
Once the future cash flows and discount rate have been determined, your broker or valuation specialist will discount each year’s future cash flows back to their present value with the following formula:
Present Value = Future Value / (1 + the discount rate)number of years
PV = FV/(1+r)n
After calculating the present value of each period, your broker or valuation specialist will sum the total and arrive at a net present value (NPV), which they can use to assign a fair value for your business.
Here’s an example of how this approach works:
Business owner Dean is interested in selling his business and contacts Meg, an experienced valuation specialist, to help him establish a fair asking price. In the year that’s just ended, his business earned $100,000 before interest, tax, depreciation, and amortization.
Meg plans to use the DCF approach and will make projections about the next five years of earnings for Dean’s business. She makes the following assumptions, based on Dean’s business’s industry, customer concentration, and unique business factors:
Assumptions: Annual growth rate equals 5%
Discount rate equals 30%
Sale multiple equals 3.0
For each year’s projection, Meg calculates the EBITDA by multiplying the previous year’s EBITDA by the annual growth rate (5%):
|Year 5||$121, 551|
Next, she divides each year’s EBITDA by the following formula:
(1+the discount rate)the year that’s being calculated
This helps her to arrive at the following calculation for each year:
Meg divides each year’s EBITDA by the above calculation for each year to determine the present value of the business’s future cash flows:
Then, she multiplies the EBITDA from year 5 ($121,551) by the sale multiple she’s selected (3.0):
$121,551 x 3.0 = $364,651.88
She divides the result by the same calculation:
Finally, Meg adds each year’s present values to arrive at the net present value, which she uses to provide Dean with a fair asking price for his business:
|Present Value: Year 1||$76,923.08|
|Present Value: Year 2||$62,130.18|
|Present Value: Year 3||$50,182.07|
|Present Value: Year 4||$40,531.67|
|Present Value: Year 5||$32,737.12|
|Present Value: Sale||$98,211.35|
|Net Present Value||$360,715.46|
Approach 3: Asset-based approach
A third approach can be used either to find the value of businesses that aren’t expected to generate a profit or to set an absolute floor value for a sale. This approach adds up the fair market value of all the tangible assets to be sold by studying what each piece could be sold for today. If a business is profitable, owners should not accept an offer that’s less than this value.
Where can I find a valuation specialist?
We can connect you with a valuation specialist who can help you to determine what your business is worth. Click the Connect button below to get started:
If you prefer, you can ask your broker to help you with the valuation, but bear in mind that a broker’s valuation may not be impartial. Many brokers are motivated to sell quickly to earn fast compensation, even if that means selling below fair market value. For this reason, a third-party valuation specialist may be a better option for assessing the true market value of your business.
What about the valuation calculators I’ve seen on other sites?
Online calculators can provide you with a baseline assessment of what your business is worth, but they’re no substitute for an expert walking through your site, asking questions and uncovering the nuances that make your business worth more or less than others in your industry. An experienced valuation professional can often provide a much more accurate estimate.
How should I proceed?
Plan to connect with a valuation specialist who can help you determine what your business is worth. You can click the Connect button below to connect with a specialist who is experienced in small business valuations.
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