Business valuation is one of the first stops on the selling journey. Although you may have big plans for your life post-sale, your ability to successfully exit your business hinges on the price you can reasonably expect to receive for it in the marketplace.
But determining the value of your business can be complicated. After you set aside your personal feelings about the company's worth, you will need to identify an objective strategy for accurately valuing the business.
3 Approaches to Business Valuation
The process for determining business value is both an art and a science. Ultimately, the most accurate value is the amount a buyer is willing to pay for the company in today's market. However, there are several approaches that can be used to establish value prior to listing your business.
The use of multipliers is generally the quickest way to get a ballpark estimate of a small business' market value. The most common types of multiples used include revenue (sales) and cash flow. Cash flow is usually calculated by adding the business' earnings before interest, taxes, depreciation and amortization (EBITDA) with the seller's discretionary earnings (SDE), which takes into account the owner's income and benefits.
Once those numbers are determined, owners can simple apply the appropriate multiplier to their revenue or cash flow data to get a decent estimate of their business' value. The trick is finding the correct multiples to use as they vary by market and business type. Nationally, for example, the average sales price of sold businesses reported on BizBuySell is 0.6 times revenue. Therefore one could expect the "average business" to sell for 0.6 times its annual revenue. Nationally, the multiple for cash flow is about 2.4. BizBuySell publishes multiple data like this in its quarterly Insights Report. Small business owners looking to estimate their businesses value can find the appropriate multiples for both their geographic location and industry type. Another excellent resource is the Business Reference Guide, now in its 24th edition, published by Business Brokerage Press. This guide includes "rules of thumb" commonly used to price businesses and franchises across hundreds of industries.
Recent sales of comparable businesses (or "comps") can eliminate the guesswork from the selection of a multiplier and help paint a strong picture of what similar businesses are selling for. By identifying and evaluating recent examples of businesses that have sold in your industry and geographic location, you can develop a better sense of what sale price is likely for your business.
Getting comps data is relatively easy. BizBuySell.com and other online sources provide lists of comps across a range of industries and geographies, allowing you to see the prices and multiples of revenue or cash flow that similar businesses have commanded in the business-for-sale market. A good business broker with a track record in your industry can also be a great source for comps data. While there will certainly be some differences between your business and the comps, lining up your features and financials side by side with the comps can help you gauge where your asking price should be.
Appraisals and Formal Valuations
The final option involves bringing in the professionals. Most business sellers can benefit from a formal valuation by a professional business appraiser. Professional appraisers understand market dynamics and are familiar with the multipliers that are used to value businesses in specific industries. A good appraiser will also conduct a valuation based on the specifics of your business using a number of methods including a Discounted Cash Flow (DCF) analysis, which is ultimately the best method and is based off an estimate of the future cash flows of the business. Many brokers are qualified to perform these valuations, and if not, will have connections with professionals who can.
But more importantly, a formal third-party valuation completely eliminates seller sentiment from the process. In addition, the involvement of a professional business appraiser can significantly shorten the sale process by aligning business value with the realities of the market.
As a seller, you have a lot riding on business valuation, and the presence of a qualified business broker can go a long way toward insulating your sale from a valuation snafu. In addition to up-to-date market knowledge and industry experience, a good business broker will have an appreciation for your concerns and can ensure that the valuation process goes as smoothly as possible.