Top 9 Reasons to Get a Business Valuation Today
If you own a small business and you are looking to sell it, retire, or move onto the next best thing…you have probably wondered over the years, how much your business is worth.
Whether you have 10 more years in business or you want to sell your business soon, here are nine compelling reasons why understanding the value of your business is crucial.
Facilitating Business Sales: When selling your business, a professional valuation provides an unbiased assessment of its fair market value, aiding in setting a realistic asking price and bolstering confidence during negotiations, benefiting both you and potential buyers. Additionally, lenders often require this valuation for financing purposes.
Strategic Exit Planning: Every business owner will eventually exit their venture. A valuation serves as a foundational step in planning your future by assessing your assets, revealing any gaps, and aiding in the creation of a strategic plan to achieve your goals.
Identifying Growth Opportunities: Valuations uncover avenues for revenue growth, such as introducing subscription-based products, while also pinpointing areas for cost reduction, improving cash flow, and enhancing overall operational efficiency.
Attracting Investors: A recent business valuation provides potential investors with a comprehensive understanding of your business's financial health, structure, and future earning potential, making it an invaluable tool for attracting private equity groups or venture capitalists.
Securing Financing: Whether for equipment purchases, renovations, or meeting payroll, a professional valuation, accompanied by detailed financials, streamlines the financing process by providing lenders with a clear picture of your business's worth and financial viability.
Insurance Needs: Detailed valuations aid in determining the appropriate insurance coverage for your business, influencing coverage amounts and potential payouts for scenarios like co-owner life insurance agreements or damage from natural disasters.
Navigating Divorce Proceedings: During divorce proceedings, a neutral business valuation assists both parties and the court in equitable distribution of assets, ensuring informed decisions regarding the inclusion of the business in asset allocation.
Buying Out Partners: In cases where a partner seeks to divest ownership, a professional appraisal determines a fair market value for the buy-out, ensuring fairness and clarity in the transaction.
Succession and Estate Planning: Valuations are vital for succession or estate planning, enabling you to make informed decisions about the future of your business in the event of unforeseen circumstances, such as death or incapacitation.
Just as regular health check-ups are essential for maintaining physical well-being, periodic evaluations of your business's value are crucial for navigating potential investment opportunities, financial challenges, and strategic decisions with confidence and clarity.
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Business Valuation Methods: What is Your Business Worth?
When you explore the sale of your business, whether with a business broker or M&A advisor, or if you choose to sell your own business yourself, you must first determine one critical number before you take the first step: Business Valuation.
When you explore the sale of your business, whether with a business broker or M&A advisor, or if you choose to sell your own business yourself, you must first determine one critical number before you take the first step: Business Valuation.
If you’ve ever wondered, “How much is my business worth?”, “small business valuation methods” or simply “how do you value a small business?”, then you have surely begun doing the appropriate research to start your business sale process.
While business valuation is based on a number of factors, a small business’s value can be boiled down into a rather simple formula that most small businesses can use to estimate their value that we will cover below.
Keep in mind that every business is unique and has dozens of factors that drive the market value, this guide will help you determine a potential valuation range that you can use as a basis for selling your business.
Small Business Valuation Methods
While each business’s actual value is up to the market of buyers to decide, most businesses are valued as a multiple of their annual earnings.
Similarly to how public company stocks are valued at a price to earnings ratio (or P/E ratio), private companies are valued based on their earnings as well, but using a more simple formula.
Small businesses use a similar metric that uses their EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization), or Seller’s Discretionary Earnings (SDE) for a twelve month period.
Depending on when the business is valued, you will typically use the last twelve months (LTM) or Trailing Twelve Months (TTM) of earnings.
Using the TTM earnings number, buyers will multiply that number by a range of 2x to 8x to arrive at a valuation that is reasonable to pay to buy a company.
Small business buyers are usually willing to pay 2-3x, while slightly larger (small businesses) can fetch multiples of 4-5x.
Exceptional businesses with very unique qualities, growth, and profitability may fetch multiples above 5x, with high value assets selling for 8x, 10x, even 12x, depending on the demand for their assets, though quite rare.
And yes, this applies to small, privately held businesses too.
In general, you will find that most small businesses with revenues up to several million dollars and 10-25% profit margins fetch valuations in the 2-4x multiple range.
Calculating EBITDA
EBITDA is a Wall Street calculation of a business’s profits that investors and buyers of all types have become accustomed to using to evaluate the profitability and value of a business.
The purpose of using EBITDA is to “normalize” or isolate the businesses operating income by eliminating the impacts of financing decisions, government taxes, and other accounting treatments to provide a pure indication of the business’s earnings.
This helps investors and buyers compare a business on a more “apples to apples” basis.
It’s also worth noting that in most cases, EBITDA is a higher number than net income - so if you have reached this point in the article and are disappointed in your potential valuation, please read on since your EBITDA is likely higher than your net income.
Also, EBITDA is more relevant to slightly larger businesses where the owner’s salary is critical to the operation of the business, and in theory, the business has established operations and staff that would continue with the business after it is sold. Usually, the owner’s salary is not added back to EBITDA.
Here is formula using example numbers:
Net Income = $500,000.
Interest Expense = $100,000
Income Taxes = $10,000
Depreciation Expense = $200,000
Amortization Expense = $20,000
EBITDA = $830,000 ($500,000 + $100,000 + $10,000 + $200,000 +$20,000)
Calculating Seller’s Discretionary Earnings (SDE)
Seller’s Discretionary Earnings is a similar method of modifying net income that is used for small businesses and banks to determine valuation and funding worthiness.
Where EBITDA includes the actual net income of a business, including deductions for the owner’s salary, Seller’s Discretionary Earnings also adds back all of the owner’s pay, benefits, and personal expenses to EBITDA, potentially further increasing the valuation potential.
This is a more relevant number for a small business so that the buyers get a clear picture of the operating profits of the business without the owner’s pay or personal expenses that will cease to exist once the business is sold.
EBITDA = $100,000.
Owner’s Salary: $100,000
Owner’s Personal Vehicle= $10,000
Owner’s Spouse Salary = $40,000
Owner’s Health Insurance = $15,000
Owner’s Personal Expenses = $5,000
SDE = $170,000 ($100,000 + $10,000 + $40,000 + $15,000 +$5,000
Business Valuation Summary
The valuation methodologies above are the most common and straightforward ways to value small businesses. If you are curious about your business valuation, you can use the general methods above for a rough idea of your business sale price potential.
If you would like a more detailed analysis, book a free valuation call with one of our business brokers today. You have nothing to lose!
