How Much Is My Business Worth? Key Factors and Methods
The first question many business owner ask at the onset of an M&A process is "How much is my business is worth?". Of course, it's one of the most important and personal aspects of the sale - but knowing the elements that influence the ultimate sale price before trying to sell a business allows founders to tackle the most important value-increasing initiatives to help maximize their future sales price.
At Exitwise, we help business owners and founders find and work with the best M&A professionals in their industry to value their business accurately and uncover actionable insights for increasing its value.
These professionals can also help you market your business to the right pool of potential buyers and sell it at the best price possible when you are ready to exit. Reach out to us today to hire the best M&A experts to maximize your business’s value and achieve the exit of your dreams.
TL;DR - How Much Is My Business Worth?
Your business can be worth several hundred thousand to millions of dollars and more, depending on the value drivers below:
Financial considerations, such as revenue, profitability, and future earnings.
Business assets, such as office equipment, machinery, intellectual property, inventory, and vehicles.
Non-financial considerations, such as reputation, geographical location, and customer concentration.
What Determines Your Business’s Value
To determine how much your business is worth, there can be a variety of things for a founder to consider. Every business is made up of unique and valuable components that sum up to determine the price that an acquiring company is willing to pay. Working with an Investment Banker or M&A Expert with industry-specific experience is the best way to receive a high-quality, accurate valuation - but first, there are factors that any business owner can and should understand prior to valuing his or her business:
Financial Considerations
Typically, the best place to start is to look at historical company revenue. Reviewing financial records from the past several years allows you to understand annualized revenues and growth trends. From there, overlaying costs gives you a view of your historical profitability and future earnings.
If you have a solid handle on your past and projected earnings (or have had an outside agency run a quality of earnings study), a discounted cash flow (DCF) analysis can be used to determine a company's value based on how much money the business will generate in the future. It’s a popular and useful technique relied upon by financial and strategic buyers when deciding how much to pay when acquiring a company. To perform the DCF analysis, you can use a variety of no cost online solutions and resources.
Business Assets
In addition to analyzing your revenue, costs, and cash flows, your company’s assets should also be taken into consideration when valuing your business. This list should include things like office equipment, vehicles, company machinery, patents, IP and inventory. Once you’ve considered the value of your company’s assets, you need to subtract corporate debt and liabilities to determine the true value of your company's assets.
Non-Financial Considerations
Financial figures are important when determining the value of your company, but a business owner also needs to consider other less tangible factors, as well. The strategic benefits your business could offer to an acquirer may be just as important as if not more important than the financials and growth rate of the business. Similarly, business owners should take into account the geographical location of their businesses, customer concentration, and the strength of the business’s reputation and brand.
How Buyers Look at Business Value
Buyers evaluate the worth of a business based on several factors, usually emphasizing financial performance and future potential.
Let’s look at these factors below:
Financial Performance: Potential buyers check for strong and consistent profitability using metrics such as Seller's Discretionary Earnings (SDE) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). They also consider the predictability and growth of cash flows.
Growth Potential: Buyers consider the scalability of your business, particularly when seeking a long-term opportunity. They also assess your market position, competitive advantage, and potential for future growth.
Customer Base: Prospective buyers want to see if you have a loyal customer base that's likely to keep buying from your business after the acquisition or merger. They also check for customer diversity to ensure you don't rely on one or a small number of clients.
Operational Efficiency: Buyers seek a business with straightforward and efficient operating processes, as these are easier to integrate into their own business ecosystem. They also check that your operating systems are scalable to accommodate future growth.
Management Team: Buyers consider the experience and expertise of your management team, and whether the business can run smoothly without the daily input of its owner.
Appropriate Valuation Methods: A potential buyer can use different business valuation methods for your business, depending on its characteristics and their acquisition plan.
Note: Different buyers can prioritize different factors. For example, internal buyers, such as employees and family members, may emphasize the continuity of the business.
External buyers, such as competitors and private equity firms, typically emphasize operational efficiency, long-term growth, and return on investment.
Ways to Calculate How Much Your Business Is Worth
You can calculate the value of a business using various methods. Here's a closer look at the most common options.
1. SDE Multiple Method
The SDE multiple valuation method is ideal for a small, owner-operated business.
Using this earnings-based method, you apply an industry-typical multiple to your annual SDE, which is the total monetary benefit you derive from the business.
For example:
Let's assume businesses similar to yours in the industry command an average SDE multiple of 2.5x, and your SDE is $300,000.
Business Value = $300,000 x 2.5 = $750,000
2. EBITDA Multiple Method
The EBITDA approach shows the number of times a business is worth its EBITDA. The method applies a market-derived multiple to your annual EBITDA.
For example, if the prevailing EBITDA multiple in your industry is 3.1x for your kind of business and your business has $5.5 million in EBITDA, it can be worth $17,050,000 ($5.5 million x 3.1).
3. Market Comparables Method
This method compares the values at which similar businesses have been sold recently in your sector. The information you get helps you calculate your business's value based on a metric multiple, such as the revenue multiple.
For instance, if a business similar to yours had $3 million in yearly revenue and sold for $12 million, its revenue multiple was 4x.
You can apply this multiple to your business. If you have $4 million in annual revenue, your business could be worth $16 million ($4 million x 4).
4. Asset-Based Valuation
The asset-based approach is ideal for businesses with numerous assets, such as those in real estate or manufacturing.
The focus is on the difference between the assets and liabilities using the formula:
Business Value = Total Assets - Total Liabilities
If you have $950,000 in assets and $130,000 in liabilities, your business will be worth $820,000.
Note: Don't forget to account for all intangible assets, such as brand reputation and goodwill, which can significantly enhance the overall business valuation.
5. Discounted Cash Flow Method
The Discounted Cash Flow (DCF) method determines the value of a business based on its potential future earnings. To do so, you apply an industry-typical discount rate to the projected cash flows to determine their present value.
The method is ideal for newer businesses with considerable growth potential, but that aren't profitable enough yet.
Here's a sample business valuation using the DCF method and the metrics below:
Year 1 Cash Flow = $3,000,000
Year 2 Cash Flow = $3,500,000
Year 3 Cash Flow = $3,900,000
Discount rate, r = 5.5% (0.055)
The formula for business valuation:
Business Value = CF₁ ÷ (1 + r)¹ + CF₂ ÷ (1 + r)² + … + CFₙ ÷ (1 + r)ⁿ
In which:
CF₁ and CF₂ = Year 1 and Year 2 cash flows, etc.
CFₙ = Cash flow in the nth year
n = The number of years in the forecast
r = Discount rate
Business Value = $3,000,000 ÷ (1 + 0.055)^1 +$3,500,000 ÷ (1 + 0.055)^2 + $3,900,000 ÷ (1 + 0.055)^3
= $2,843,601 + $3,144,583 + $3,321,293 = $9,309,477
A lot of these calculations can be overwhelming. However, with the right professionals, you can easily assess the value of your business.
Merger and acquisition experts like bankers, lawyers, accountants, and others can help you select the right valuation method and accurately estimate your business’s worth.
Consult with us at Exitwise for help finding the right M&A professionals to value your business.
Common Pitfalls That Hurt Business Value
It's not all roses when it comes to maintaining or increasing the value of a business. You might encounter common pitfalls that could reduce the value, such as:
Poor Documentation: Unreliable financial records can reduce business value as valuers will have to rely on inaccurate or incomplete information. Potential buyers may see poor documentation as a red flag and value your business at a lower rate.
Poor Marketing: Failing to market effectively can result in low brand visibility, missed sales opportunities, and difficulty reaching potential customers. A significant decrease in brand recognition and revenue can translate into a lower valuation.
Ignoring Intangible Assets: You can undervalue your business if you overlook intellectual property, brand recognition, strong customer relationships, and other intangible assets.
Poor Management: Business owners and managers who neglect daily operations can damage business performance and reduce the value of the business.
Relying Solely on DIY Valuations: Do-it-yourself valuations can be inaccurate and subjective, leading to undervaluation. A professional valuation is important to ensure objectivity and greater accuracy.
Knowing Your Valuation Early, And Creating A Plan For Your Future
If you find that your business is not worth as much as you were expecting, it might be time to better understand the quality and sustainability of your company's earnings, and consider making some changes before starting a full exit process. The most obvious way to increase your valuation is to grow the profitability of the business. To do this, you should look for ways to cut overhead costs, streamline operational processes and explore new avenues to increase sales. You might also want to consider revisiting ways to increase your streams of recurring revenues. For example, if you’re a service-based business, see if you can extend current maintenance contracts or generate new contracts with customers or clients.
Other non-finance related changes can help, as well. Reconsidering the efficiency of your marketing efforts, changing the way you incentivize your sales organization, and developing new and creative industry partnerships are some of the ways many companies change their valuation profile in a short period of time.
Lastly, a focus on company culture can be an easily overlooked aspect of a company's value. Engaged employees, especially those that support the company's most valued clients and customers, are some of the most important people in your organization. Reviewing compensation, employee benefits, and creating a culture that enables creative support of your customer base should be the focus of any business owner looking at selling their company.
For more information on how to accurately calculate the value of your company before you sell, read, 4 Ways to Calculate the Value of Your Company or go to our Business Valuation Calculator to receive a free evaluation.
Frequently Asked Questions (FAQs)
Let's explore some common questions business owners often ask about the value of their businesses:
Do I Need a Formal Valuation to Sell My Business?
Generally, you don't need a formal valuation to sell your business, especially if it's small and easy to value independently.
However, a formal valuation is advisable to get an accurate value or align with the valuation purpose, such as when you need to comply with a legal requirement in estate planning.
At Exitwise, we can help you get a detailed formal valuation that considers the unique aspects of your business. Check out our certified professional valuation services today.
How Much Does a Business Valuation Cost?
A business valuation can cost several thousand to hundreds of thousands of dollars or more, depending on the valuation purpose and the size and complexity of your business.
For example, a multi-location business valuation can be more expensive to conduct because it requires additional time and human expertise.
Do Online Valuation Tools Work?
Online business valuation tools work when you need a basic overview of how much your business is worth.
You'll need professional appraisers for deeper insights and to capture your company's unique nuances.
Conclusion
It doesn't have to be a struggle to calculate how much your business is worth. Once you understand the valuation methods and the factors that drive the value, such as financial and non-financial considerations, you can even calculate the value yourself.
However, it's better to work with professional valuers to remain objective and capture all the specific characteristics that could significantly increase your business's value.
We can help you recruit and manage the ideal industry-specific M&A team for an in-depth valuation.
Connect with us at Exitwise to onboard the best M&A experts to value your business accurately and even sell it for more money.
