Years ago I owned a little marketing and design agency and would rely on the multiples the big advertising agency holding companies got on the stock exchange to figure out its value. I'd assumed that, because Omnicom was trading at 22 times earnings, my little agency with $150,000 in profit was worth around $3 million.
I got a wake up call at an industry event when I found out that, in actuality, small ad agencies with less than $5 million in revenue were lucky to get three or four times pre-tax profit—much of which was tied to achieving goals in the future.
Since then, I have started a couple of other businesses and gotten a bit better at estimating their value. It's still tricky and ultimately a business is only worth what someone will pay for it. But I found I could cobble together a decent estimate through a few resources:
A fancy lunch with a professional
When I went to sell my research company, I bought lunch for three mergers and acquisitions professionals. Each had experience selling research companies similar in size to mine. Their back-of-the-napkin estimates all ended up being plus or minus 25 percent of the actual selling price.
Business Valuation Resources
Business Valuation Resources (BVR) gathers historical information about businesses that have sold recently and comes up with some industry norms.
I found BVR to be a good start, but oftentimes its descriptions of industries were too generic to make for good apples-to-apples comparisons.
M&A firm newsletters
Some mergers and acquisitions firms publish newsletters that will describe the kind of multiples being paid on deals they have done. For example, when I was preparing to sell my conference business, I looked at the newsletter from the Jordan Edmiston Group, one of the top M&A firms in the conference business.
I found that the problem with the M&A firms as a source for valuation data is that they tend to overemphasize their biggest deals. M&A firms get paid on deal size and spend a lot of their time trying to convince the world (and prospective sellers) they do big deals. It's also the way they measure themselves and earn bragging rights over cocktails. Unfortunately, it ensures they (and their newsletters) boast about the one deal they did with a valuation of $100 million instead of the 15 deals they did for businesses worth less than $20 million.
Bizbuysell.com is the largest online marketplace for businesses for sale. I think of it as an eBay for businesses. If you own a dry cleaning shop in Seattle, you can advertise it on bizbuysell.com. Likewise, if you want to buy a retail business in Nashville, you can query bizbuysell.com by industry and identify businesses that meet your specs.
The downside of bizbuysell.com is that it tends to attract smaller, main street businesses—which is great if you own a coffee shop or lawn maintenance business, not as helpful if you own a larger, unique business.
In the end, I have found using all four of these sources usually enables me to estimate a company's value within 20 percent of the final selling price. Not perfect, but a lot more accurate than looking at what billion dollar public companies trade for on the stock exchange.
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a sellable company at http://www.BuiltToSell.com/blog. You can also follow him on Twitter at @JohnWarrillow.