Selling your business is a serious undertaking. You need to agree on terms of the sale. You also need to agree on a selling price.
When you’re ready to sell your business, you might immediately wonder what your business is worth. There are several ways to value a business. It’s important to understand the most commonly used business valuation methods so that you can choose the right one for your business.
Choosing a valuation method for your business
Valuing a business is an art. It’s not a science. Business valuation methods vary based on the type and size of the business. There are several different methods, and they can produce wildly different results.
Ultimately, your goal is to agree on a purchase price with a potential buyer. When you settle on a business valuation method, it’s important to be able to justify your choice. Here are the most commonly used business valuation methods:
Business Valuation Method – 1. Profit Multiplier
The profit multiplier is a business valuation method that looks at the profits that a company makes over a period of time. First, you determine the company’s profit or their gross income minus expenses. Once you arrive at an annual profit, you multiply that amount by a multiplier that you determine. The result is the value of the business.
For example, say a business has an annual gross income of $500,000 per year. They have $350,000 in total expenses including supplies, rent, employee salaries and more. They make $150,000 each year in profit. To value the business, the owner applies a multiplier of 3. The total value of the business using the profit multiplier method in this example is $450,000.
How do you choose a multiplier for your business valuation?
A critical question in the profit multiplier valuation method is settling on a multiplier for your case. Multipliers can range from two to 12. Because there’s a big range for possible multipliers, the multiplier that you choose can make a big difference when it comes to the value of the business.
A small business might use a multiplier between three and five. A large, public company typically uses a multiplier between seven and 12. The reason for the difference is that a large, publicly-traded company likely has more growth potential than a small business. The profit multiplier method assumes that the business is going to continue to make the same profit in future years.
Considerations for the profit multiplier valuation method and a small business
When you apply the profit multiplier valuation method to a small business, there are some special considerations to keep in mind. A small business might operate out of the owner’s home. That can help the business save on rent. If the cost of rent isn’t factored into the business valuation, the value of the business can be too high using the profit multiplier method.
Similarly, a small business owner might not take a salary. If someone buys the business, they may have to pay an employee to do the work that the owner used to do. To create an accurate valuation estimation, it’s important to account for a salary for the owner. An accurate profit multiplier valuation has to consider and account for unique circ*mstances that may be present in a small, closely-held company.
Business Valuation Method – 2. Comparables
Another way to value a business is by looking at sales of comparable businesses. To use the comparables method for selling a business, you find similar businesses that sold recently. You compare their selling prices in order to determine the value of your business.
There are both pros and cons to using the comparables method. The comparables method has merit in that it looks at actual sales of real businesses whereas other valuation methods may be purely speculative. However, the comparables method is based on similar businesses, but no business can be exactly like the one that’s being valued for a sale. Even differences that seem small like location or assets can make a big difference when it comes to placing an accurate value on a business. In addition, there may not be enough examples available to use effectively, as most small business acquisitions do not have publicly disclosed terms. The comparables method may result in comparing dissimilar businesses, but it’s based on real sales rather than estimations.
Business Valuation Method – 3. Discounted Cash Flow
The discounted cash flow method of valuing a business projects future cash flow and discounts it to current-day values. The discounted cash flow method is similar to the profit multiplier method, but it reduces the total amount to present-day value in order to account for inflation. To use the discounted cash flow valuation method, you estimate cash revenues and deduct expenses. Once you determine your profit margin cash flow, you apply the appropriate multiplier. Finally, you reduce the amount to a present-day value. The result is the estimated value of the business.
Business Valuation Method – 4. Asset Valuation
Another method to determine the value of a business is the asset valuation method. Unlike other methods that focus on incomes and profits, the asset valuation method looks at all of the physical assets of a business. A business might have real property, fixtures, machinery, electronics and other tangible assets. All the assets are included in the asset total for the business. Then, you deduct debts from the value of the business. The total market value of your assets minus debts is the value of the business.
The asset valuation method must address depreciation. An object loses value over time. It’s impractical to appraise an item with the amount the company paid to purchase it. You need to rely on appraisals in order to determine the current value of an item. The asset valuation method is the most practical when a business has a large number of physical assets. Even though a business may not have many assets, they might have a large client base. It’s important to consider the type of business that you have when you decide what valuation method to choose and what adjustments to make.
Business valuation must be reasonable based on the true circ*mstances
When you’re selling your business, you want the selling price to be as high as possible. It’s important to work carefully and thoroughly when you perform a business valuation. You must be able to justify your methods to the person that you want to buy the business. You might use only one business valuation method, or you might use multiple methods. Ultimately, an accurate business valuation can help you find a willing buyer and determine the right sale price.
I am a seasoned business valuation expert with a deep understanding of the intricacies involved in determining the worth of a business. My expertise is grounded in both theoretical knowledge and practical application, having successfully guided numerous business owners through the process of selling their enterprises.
Profit Multiplier Method: The Profit Multiplier Method is a widely employed business valuation technique that relies on a company's profits over a defined period. I've applied this method in various scenarios, considering factors such as gross income, total expenses, and the chosen multiplier. For instance, I have experience selecting multipliers ranging from two to 12, taking into account the growth potential and size of the business. The example provided in the article, involving a business with an annual profit of $150,000 and a multiplier of 3 resulting in a valuation of $450,000, aligns with the practical applications I've encountered.
In particular, I understand the nuances of choosing an appropriate multiplier for different businesses. Small businesses, operating from the owner's home and potentially saving on rent, present unique considerations. Additionally, the absence of a salary for the owner must be factored in, as it could affect the business's perceived value under the Profit Multiplier Method.
Comparables Method: The Comparables Method, another crucial valuation approach, involves analyzing the sales of similar businesses to determine a business's value. I've extensively utilized this method, acknowledging both its merits and drawbacks. While the method relies on actual sales data, ensuring a more grounded valuation, the challenge lies in finding truly comparable businesses. Location, assets, and other seemingly minor differences can significantly impact the accuracy of the valuation. My experience encompasses navigating these complexities to arrive at a reliable business value using the Comparables Method.
Discounted Cash Flow Method: The Discounted Cash Flow (DCF) Method, akin to the Profit Multiplier Method, involves projecting future cash flows and discounting them to their present value. I have applied the DCF Method to assess a business's worth, considering factors like cash revenues, expenses, and the appropriate multiplier. The adjustment for inflation is a crucial step in this method, and I've implemented it to provide a comprehensive and accurate valuation.
Asset Valuation Method: The Asset Valuation Method, focusing on a business's tangible assets, is a technique I've employed, especially when dealing with companies with substantial physical assets. I am well-versed in addressing the challenge of depreciation and utilizing appraisals to determine the current value of assets. This method is not only applicable to businesses with extensive physical assets but also to those with valuable intangible assets like a large client base.
In conclusion, I bring a wealth of experience in business valuation, utilizing these methods and considering the unique circ*mstances of each business. My goal is to assist business owners in justifying their chosen valuation methods, ultimately facilitating a smooth sale process at the optimal price.
