When it comes to valuations, no single business valuation model is perfect for every industry or business, and choosing the best model from a cluster can be overwhelming. But don’t worry—making this critical decision doesn't have to be a chore anymore!
We’ll guide you through the decision, helping you find the most suitable one so you can set up your business for future growth or a successful exit.
Here's an in-depth guide to different valuation models and some corresponding valuation methods. We'll also discuss the importance of evaluating your business, how to evaluate it, and how you can find the best M&A experts to help you.
Below is a quick list of the four main business valuation models before we discuss them further in a later section:
A business valuation can help you make the best decisions for the future of your business, including a potential exit.
At Exitwise, we can help you make crucial valuation-related decisions to maximize your business's value or even sell it at a significant profit. Schedule a chat with our team today to hire the best M&A experts.
Business valuations offer crucial benefits to both investors and business owners. Let's check out a few:
Let's discuss the four most common valuation models in M&A:
The market-based valuation model considers the prevailing valuation ranges or sale multiples in a given industry.
You can use either the comparable company analysis or precedent transactions analysis:
Using this method, you can compare valuation multiples such as revenue, EBITDA, and SDE.
For example, if your company has $2 million in annual earnings and the prevailing industry EBITDA multiple is 10x, it can sell at $20 million.
You can then make a judgment of your business's worth based on the multiples that correspond with the financial metrics you have.
The market-based model is ideal as a checkpoint for other valuation models, showing whether their outcomes align with current market trends.
You can use the asset-based model if your business isn't highly profitable yet and has much of its worth tied to net assets and total liabilities.
The method considers all of a company's assets and liabilities at their market value as of the date of the valuation:
Business Value = Net assets (at market value) - Net liabilities (at market value)
One way to increase your business's future growth prospects and sale price is to reduce its dependence on you as the owner or operator or other key employees.
The earnings-based model offers a way to assess your business's past and future ability to generate cash flows or earnings (profits).
You can use this model if your business has significant expected future earnings, meaning it is highly likely to earn returns on the assets you use in your operations. Your current earnings should also be stable and with minimal downward changes year over year.
The capitalized cash flow (CCF) earnings method is common under this model, using a market-derived capitalization rate to convert the annual cash flow to its present value:
Business Value = Annual cash flow ÷ Capitalization rate
Under the income-based model, you estimate the value of a business based on its future income potential, where ‘income’ refers to ‘gross income’ after you've accounted for the costs related to producing goods or services.
The DCF is the most popular method under this model. It uses a discount rate to show the present value of projected future cash flows.
The DCF uses the formula below:
DCF = CF₁ ÷ (1 + r)¹ + CF₂ ÷ (1 + r)² + … + CFₙ ÷ (1 + r)ⁿ
Where;
In this section, we'll briefly discuss some valuation techniques and methods using the four models mentioned earlier:
Here’s how to evaluate a business using the revenue multiple method under the market-based valuation model:
Assuming similar businesses have recently sold at an average revenue multiple of 0.52x and your business's average annual revenue is $1.5 million,
Business Value = Average annual revenue x Average revenue multiple
= $1.5 million x 0.52 = $780,000
The net assets or asset accumulation method uses the formula:
Business Value = Net assets - Net liabilities
Assuming you have $5 million in net assets and $2 million in net liabilities, your business's value is $3 million.
Here’s how to evaluate a company's value using the capitalized earnings method under the earnings-based model:
Business Value = Annual cash flow ÷ Capitalization rate
The capitalization rate is a market-derived metric that uses a business’s current annual cash flow to estimate its present value, representing the rate of return an investor can expect from the business.
If your business's projected annual free cash flow is $20 million and the market projects a 10% return on such investments,
Business Value = $20 million ÷ 10% = $200 million
Let’s assume a company has the following financial metrics:
Year 1 cash flow = $3,400,000
Year 2 cash flow = $3,700,000
Discount rate, r = 4.5% (0.045)
Here’s how to evaluate the company's worth:
DCF = CF₁ ÷ (1 + r)¹ + CF₂ ÷ (1 + r)² + … + CFₙ ÷ (1 + r)ⁿ
DCF = $3,400,000 ÷ (1 + 0.045)^1 + $3,700,000 ÷ (1 + 0.045)^2
DCF = $3,253,588 + $3,388,200 = $6,641,788
The business value would be $6,641,788.
Many factors go into choosing a business valuation, including:
Here are the steps to value your company accurately:
You'll need your company's past or historical financial data to understand its patterns and stability across revenues, expenses, assets, taxes, and liabilities.
Gather internal financial statements and details for the past 3-5 years, including cash flow statements, tax records, income statements, and balance sheets.
You'll also need to gather external financial information, such as industry valuation multiples, to compare your company's financial health and valuation against its peers.
Use the data from step one to analyze key metrics such as net income, expenses, and profit margins to see how much your business earns.
You can also assess revenue growth over the years to project its future growth.
In addition, check your company's financial leverage by analyzing its debt-to-equity ratio.
You'll want to use multiple valuation methods to better understand how much your company is worth.
The most common methods include discounted cash flow, capitalized earnings, and asset accumulation.
Use the corresponding formulas for the chosen valuation methods to calculate business value.
A huge mistake some owners make is leaving out qualitative aspects when valuing a company.
You should consider factors such as owner-operator involvement, prevailing industry trends, the quality of your company's management, and your competitive advantage.
For this last step, perform a sensitivity analysis where applicable to see how different assumptions can affect the valuation.
For example, using the DCF formula, you can adjust the discount rate to higher or lower levels to see how a perceived higher or lower risk level could affect the value.
You can also review and explain the differences in the various values obtained from different methods before you declare a final valuation range in your report.
Assessing your business, deciding on the best valuation model, and calculating its value can be stressful.
In addition, finding the right M&A experts on your own can be confusing and time-consuming. But you don't have to do all these things yourself.
At Exitwise, we can help you find and work with the best M&A experts in your industry. Here's how our proven system works:
You can rely on our proven system and professional team to achieve the exit of your dreams. Reach out to us today to get started!
Let's wrap this up with a few common questions about business valuation models:
Internal factors that influence business valuations the most include owner-operator involvement, overall financial health, the quality of management and other employees, and a company's development stage.
External factors that influence valuation the most include the state of the M&A market and the general economic outlook.
When you work with Exitwise, we help you choose M&A experts who can help you address critical factors to ensure your business valuation remains high over time.
Industry valuation techniques differ across industries, depending on the state of the industry, valuation purpose, and the state of the individual business.
For example, asset-based valuations are ideal for manufacturing and real estate companies because they typically have significant tangible assets, but their revenues and profits aren't up to par yet.
When valuing a small business, critical criteria can include revenue and cash flow growth year over year, profit margins, the level of involvement as the owner or operator, and customer distribution.
An increase in revenues, cash flows, and profit margins can signal better future performance, while too much owner involvement and poor customer distribution can indicate higher risks.
Choosing the best business valuation model can be tricky since every business is unique. Exitwise can help you recruit and work with top business valuation service experts to help you choose the best model, value your business, and offer insights for better future growth.
Additionally, these experts can help you sell your business faster and at the best sale price if you are looking to exit. Let’s connect today so we can connect you with the best M&A experts to secure your business's future growth and successful exit.
Let Exitwise introduce, hire and manage the best, industry specialized, investment bankers, M&A attorneys, tax accountants and other M&A advisors to help you maximize the sale of your business.
