Is your business worth ten bucks? Or ten million?
Not knowing the worth of your small business can put you at a disadvantage, especially if you’re considering selling or taking on investors/partners.
After all, how can you accurately assess potential investments, partners, and acquisition offers if you don’t know the value of your own business?
My name is AJ, and I sold my business in 2022 for multiple seven figures.
After going through the wringer with my first sale, I’ve put all of my knowledge into this guide so that you, the small business owner, can get an accurate valuation!
Let’s dive in!
Key Takeaways
- A business valuation will give you an accurate snapshot of your company's worth.
- It can take anywhere from a few weeks to several months, depending on the complexity of your company.
- High valuations aren't always great, as they may make attracting investors or gaining flexibility in deals difficult.
- Researching industry multipliers and adding back large expenses will help give you a more accurate company valuation.
What is a Business Valuation?
A business valuation is the process of determining the economic value of your business.
This involves assessing both tangible and intangible assets. Valuation often includes financial analysis, market research, and industry trends.
The purpose of valuing a business is to determine its fair market value, which can be used for various purposes including:
- Buying and selling a business
- Raising funds from external investors
- Making decisions on mergers and acquisitions
- Identifying weaknesses and opportunities
Think of it like this—when you buy a house, you need to know the estimated value of the property to determine how much to pay. Business valuations work in a similar way.
Business Valuation Methods
You can use several business valuation methods to get an accurate idea of the worth of your small business.
Each has advantages and disadvantages, so choose the one that best fits your needs.
Market Capitalization
This method is used to determine the value of a publicly traded company. It involves looking at the company’s current stock price and multiplying it by the number of outstanding shares.
This gives you an estimated market capitalization, which can be used to compare your company to similar ones.
The advantage of this method is that it provides an up-to-date snapshot of your business’s worth in the eyes of investors.
The disadvantage is that external factors, such as market fluctuations, can affect it.
This method is challenging for small businesses because we’re not publicly traded.
Times Revenue Method
This method uses the company’s revenue to estimate its value.
It involves multiplying the annual revenue by a specific number, usually between one and three, depending on the type of business.
The advantage of this method is that it gives you an idea of how much your business earns in relation to its size.
However, the downside is that it doesn’t consider other factors, such as cash flow, profit margins, and market trends.
Earning Multiplier
This method is used to calculate the value of a business based on its income. It involves multiplying the company’s net earnings by an industry-specific multiplier.
Here are a few of the different popular multipliers.
EBITDA Multiplier
This method is used to estimate the value of a business based on its earnings before interest, tax, depreciation and amortization (EBITDA).
It involves multiplying the company’s EBITDA by an industry-specific multiplier. Again, specific industries have different multipliers due to cost structure and other factors.
To put it more simply, EBITDA is your earnings minus your expenses.
Sellers Discretionary Earnings Multiplier
This method calculates a business’s value based on its Seller’s Discretionary Earnings (SDE).
The main difference between the EBITA multiplier and the SDE multiplier is that the latter considers the owner’s salary and other discretionary expenses.
It involves multiplying a company’s SDE by an industry-specific multiplier.
Again, to put it simply SDE multiplier is EBITDA + adding back what you (the owner) paid yourself.
This is particularly popular if an owner-operator paid themselves a TON of money year after year, but you (the person acquiring the business) would only have to pay a modest salary to hire someone to replace them.
Discounted Cash Flow
The discounted cash flow method calculates a business’s value based on future cash flows. Future earnings are discounted to account for the time value of money.
It involves forecasting the company’s cash flows over a certain period and discounting them back to present value using an appropriate rate of return.
The advantage of this method is that it considers expected growth and other factors, such as interest rates and inflation.
However, it can be complex to calculate, requiring extensive research, analysis, and forecasting.
Enterprise Value
This method is used to calculate the value of a company based on its enterprise value.
Enterprise value includes the company’s market capitalization, debt, and cash. It does not include any intangible assets, such as intellectual property.
You find the enterprise value by subtracting the cash and debt from the market capitalization.
The advantage of this method is that it considers both tangible and intangible assets. However, it can be challenging to estimate the value of intangible assets accurately.
Book Value
This method is used to calculate the value of a company based on its book value.
Book value is the total value of all assets minus liabilities, which gives you an idea of how much the business would be worth if it were liquidated.
This method is straightforward but doesn’t consider intangible assets or future growth potential.
Liquidation Value
This method is used to calculate the value of a business if it needs to be liquidated.
It involves calculating the total value of all assets minus liabilities and any outstanding debts.
Usually, the liquidation value is lower than the book value as it does not include intangible assets such as intellectual property.
An upside to this method is that it’s easy to calculate and gives you an idea of what your company would be worth if it had to be sold quickly.
Pre-Money Vs. Post Money Valuation
These two terms are often used when discussing venture capital investments.
What is a Pre-Money Valuation?
A pre-money valuation is the estimated value of a company before any investment is made.
It’s typically based on one of the valuation methods listed above and determines how much equity investors will receive in exchange for their funds.
What is a Post Money Valuation?
A post-money valuation is the estimated value of a company after an investment has been made.
This figure includes the investor’s contribution and any additional equity granted in exchange for their funds.
It’s important to remember that pre-money and post-money valuations are estimates—they can change over time as the company’s value increases or decreases.
How Often Does a Business Valuation Need to Be Performed?
The frequency of a business valuation depends on the purpose of the valuation.
Never
Your business might not need to be valued if you’re not looking for investment or selling the business.
Every One-Two Years
If you’re looking for investment or selling the business, performing a valuation every one-two years is recommended.
This will help you keep track of your company’s growth and give potential investors an accurate picture of your worth.
Regularly
If you’re looking for venture capital investment, having your business valued regularly is recommended.
Or, if you’re dealing with an industry subject to frequent market fluctuations, it may be necessary to have your business valued more often.
This will help you track your company’s progress and make sound decisions. It will also give potential investors an accurate snapshot of the company’s value.
Things to Consider Before Getting a Business Valuation
Before you get a business valuation, there are some things to consider.
Business valuation determines the worth of your business, so it’s essential to be aware of the process and potential pitfalls.
A Valuation Takes Time
A company valuation can take anywhere from a few weeks to several months, depending on the complexity of your company.
Many different aspects need to be looked at, including the following:
- Financial statements
- Business assets and liabilities
- Market trends
- Industry-specific metrics
High Valuations Aren’t Always Great (Unless You’re Exiting)
It’s important to remember that a high valuation isn’t always the best thing.
If you’re trying to raise capital, investors may not be willing to invest in a business if it has been overvalued.
Example: You raise a round of funding at a 100 million dollar valuation. After three years, if your company hasn’t grown, investors won’t be interested in participating in a series B,C,D if your valuation has went down.
If you are exiting, a higher valuation can be beneficial as it will help you maximize the proceeds from the sale.
However, setting realistic expectations and ensuring the valuation is based on accurate information is important.
High Valuations Mean Less Flexibility
Businesses with high valuations typically have less flexibility in financing or structuring deals.
This means that the terms of an agreement must be more favorable for investors to make the deal attractive enough for them.
Do you want to ensure you get the best business terms? Of course, you do!
How to Value Your Business
Valuing your business is essential in understanding its worth and planning for the future.
It’s essential to use the proper valuation method, do your research, and set realistic expectations.
By following the steps below, you can accurately find your business value and maximize its potential.
Step 1: Review Your Financials
Reviewing your financials is a critical first step in valuing your business.
This will give you a better understanding of your current financial position and help you identify any potential risks or opportunities.
Your financials should include the following:
- Profit and loss statements
- Balance sheets
- Cash flow statements
Step 2: Get Your EBITA Number
For the sake of this example, we’ll be using EBITDA as your valuation method. However, choose the one that you think best fits your business above!
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Step 3: Add Back Any Large Expenses
Adding significant expenses such as one-time costs or non-recurring items may be beneficial in some cases.
This will give you a more accurate picture of your business’s profits.
Note: If your business had several significant, one-time expenses, this will typically get added back. When I sold my business we had over $50,000 in furniture expenses from the year before I sold, which amounted to an additional $200,000 in valuation!
Step 4: Research Your Industry Multiplier
The industry multiplier is a method of valuing businesses that focuses on specific industries.
It involves taking the company’s EBITA and multiplying it by an industry-specific multiple.
This multiple can be found through market research or a business valuation calculator.
Service Businesses: 1-4x EBITA
Service businesses often have lower multiples due to the lack of tangible assets and their reliance on personnel.
These businesses are typically valued at 1-4x EBITA. For example, if a company’s net income is 1,000,000, the business would be valued at 1-4 million.
SaaS Companies: 8-12x EBITA
Software as a Service (SaaS) companies typically have higher multiples due to their high growth potential and lack of tangible assets.
These businesses are typically valued at 8-12 x EBITA. For example, if a company’s net income is 1,000,000, the business would be valued at 8-12 million.
Step 5: Get a Rough Number
Now that you’ve researched, it’s time to get a rough number for your business’s value.
Take the industry multiplier and multiply it by your EBITA. This will give you a rough estimate of your company’s value.
Business Valuation Example
Imagine you have a service-based business; in my case, I had a digital agency selling SEO services.
The following is an example of how a business could be valued.
- Gross Revenue: $5,000,000
- EBITA: $1,000,000
- Large Expenses Add Backs: $200,000
- Multiple: 4x
- Valuation: $4,800,000
As you can see, the value of this business would be estimated at $4.8 million. This rough estimate is based on industry research and doesn’t consider additional factors.
Conclusion
The valuation process can be complex and time-consuming, but it’s essential to understand your worth to make informed decisions about investments or sales.
By following the steps outlined above, you’ll be able to get a rough estimate of your company’s value and use that information to make sound decisions for the future.
Was there anything that we missed? Let us know in the comments below. Good luck!
FAQs about topic
The value of a business with $1 million in sales depends on many factors, such as the industry, company size, profitability, and financial situation. It isn’t easy to give an exact answer without more information.
Market comparison, discounted cash flow analysis, and industry multipliers are the three main ways to value a company. Each method has advantages and disadvantages, so it’s important to understand them before making decisions.
The exact multiple of profit a business is worth depends on many factors. Generally speaking, service-based businesses are typically valued at 1 to 4 times EBITA, and SaaS companies are usually valued at 8 to 12 times EBITA. However, this can vary greatly depending on the industry and company size.
The rule of thumb for valuing a business is to use industry multiples based on EBITA. This will give you a rough estimate of the company’s value, which can be used as a starting point for further research and analysis. It’s important to remember that this number is just a guideline and may not reflect the actual market value. The best way to determine a business’s value is through careful analysis and research.
Valuing a business based on profit is done by taking the company’s EBITA and multiplying it by an industry-specific multiple. This multiple can be found through market research or using a business valuation calculator. It’s important to note that this method only gives you a rough estimate of the company’s value, and additional factors should be considered.
The most value to a company comes from having a strong financial position, growth potential, and competitive advantage. These factors will help you maximize your profits and create long-term value for your business.