You can’t guess what your small business is worth. You need an accurate business valuation for the market value. That’s important if you’re going to sell a business. And for a variety of other reasons.
To learn more about buying a business, download the BizBuySell Guide to Buying a Small Business. Or if you’re selling a business, download the BizBuySell Guide to Selling Your Small Business.
What is Business Valuation?
Business valuation is the process of determining what your business is worth. It involves fair market value. There are three methods commonly used. These include an asset-based, market value, or earnings value approach.
Business owners want to know what their companies are worth. And the same goes for those who want to buy a business. You might need to have that number for tax purposes. Or you might want to buy one of your partners out or just sell the company.
Read on to find the process for arriving at this price.
Reasons to Value Your Business
There are good reasons why you should know what your business is worth. Following are some good methods of providing accurate information. And these reasons why business valuations matter.
- You are selling your small business to a third party.
- Litigation like divorce proceedings is forcing you to sell.
- Knowing your business’s value helps you understand its strengths and weaknesses.
- This helps when you are trying to raise capital.
- You need one of these for an SBA loan.
- A valuation helps with estate planning. Or when you’re looking at retirement.
Read on to find out the steps that go into valuing a business.
How to Value a Business
Business owners might need some help putting this together. Look for a chartered business valuator or broker that knows business value methods. Like forecast future cash flows and replacement costs.
Small business owners who are selling generally need to produce some of the following:
- A letter of intent. This legal document lists the transaction terms and the deposit on the business. Other valuation terms are included.
- A purchase agreement is also included. This locks the buyer into purchasing for the agreed to business’s value. There are other agreed to terms beyond the money involved.
- The buyer’s due diligence needs to be included with the letter of intent.
It’s important to understand all of the state and local laws involved. Some of these can mean working through different consent choices. You can start by trying a business valuation calculator to give you an idea of what your business is worth.
Collect Your Financial Documents
The value of your business will hinge partially on financial documents. Your company will need to produce a list that includes the following:
- Profit and loss statements for the last 3 years. This is one of the valuation methods often required by law. It also helps a potential buyer see your income.
- Distribution and Supplier Contracts: Among other things, these itemize the different materials from your business that are supplied.
- An Up To Date Balance Sheet. This should include items like company inventories and prepaid expenses. Equipment and intangible assets need to be part of a good balance sheet too.
- Cash Flow Statements. These involve important business metrics like operating activities.
- Tax returns for two or three years. Another important financial document that helps determine the value of a business.
There are other financial valuation metrics. Putting them all together will allow you to arrive at a fair asking price. If your business is international, you’ll need to understand EU privacy laws. These include the General Data Protection Regulation (GDPR) that covers the transfer of data.
Create a List of Intangible Assets
Intangible assets are the ones a business has that aren’t physical. Nevertheless, they add value to any company. Examples include trademarks and patents as well as copyrights and the equity in your brand.
Here are some of the other intangible assets that need to go into a business valuation:
- Goodwill. This is one of the most common types of intangible assets. This is considered a premium that gets paid for the market value a company already has.
- Patented technology. This can include databases, trade secrets and computer software. A patent is a legal right granted to an inventor. They affect the valuation of a business.
- Copyrights. This depends on the kind of company being sold. That’s because copyrights usually deal with items like musical works photographs, pictures, and audiovisual items.
- Different contracts and agreements. These include items like license agreements and broadcasting permits as well as right of way and use rights.
The value of Internet domain names needs to be included.
Collect Other Essential Documents
Here are some other essential documents to determine a business’s value. Any company needs to provide business and financial statements. Like the following:
- Forecasts and Projections. You can include a balance sheet and income statements.
- Organization Documents and Business Plans. Information here can include the strategic direction the company is traveling in.
- Intellectual Capital. This is an intangible asset used in a complete business valuation. There are four different categories including human capital social capital, structural capital, and customer capital.
- Tax Returns. Usually, a business valuation needs two years’ worth of these. You might need up to three years if you’re dealing with an SBA loan. A sole proprietorship might also need to include personal returns.
Once you have this business information put together, you can determine the value of your enterprise.
There are other documents that need to be included in some situations. Like partners process data where applicable. This is an outline for each role.
Business Valuation Methods
Determining the value of your business isn’t always straightforward. There are several different ways to arrive at a valuation.
Following are a few valuation methods.
The Adjusted Net Asset Method
Companies can use this business valuation method. It takes a look at the liabilities and assets to arrive at a fair market value. It includes both intangible and tangible assets. It’s a small business valuation method that also looks at cash flow.
The liquidation value comes into play here. These include equipment machinery and other tangible business assets like real estate.
The Multiple of Earnings Method
This business valuation method arrives at a value by looking at a small businesses’ profits. It multiplies the money for any year or number of years. That’s the way it comes up for evaluation for sale.
The revenue method is another option to price a company. It uses multiples of current values. It’s another one of the business valuation methods that’s commonly used.
Capitalization of Earnings
This is another one of the small business valuation methods. It calculates the worth of projected profits based on the current earnings and the projected future performance. Businesses can use this method that’s considered part of the income approach model.
The cap rate is also important. It shows the potential ROI of a real estate investment. This is also called the capitalization rate.
Discounted Cash Flow Method (DCF)
Discounted cash flow is another option to arrive at a business valuation. The DCF takes a look at the predicted cash flows of a company. It works by determining a company or project’s value this way.
Market Value-Based Valuation
This type of valuation looks at a business’s value based on how the market works in similar situations. Simply put, it assigns a value based on similar businesses. Like ones that have recently sold. It’s a common business valuation method. It gets used for other types of properties like commercial land and residential homes.
Book Value
This is one of the easier business valuation methods. Take the business’s assets and total them. Then subtract all the liabilities. It’s an easy method to value manufacturing companies.
Return on Investment (ROI)
Companies can use this method to find out their worth. It’s an important approach. It’s a method used to calculate how much you’ll get from a business investment. You’ll need to pull multiple factors together. One quick approach is to go over a balance sheet with your accountant.
Content measurement can come into play here. You can measure ROI on digital marketing campaigns to measure performance.
Market Capitalization
This is a straightforward business valuator. It’s the value of companies on the stock market. You can calculate this by multiplying the number by the share price.
Earnings Before Interest Taxes (EBITDA) or Sellers Discretionary Earnings
This (EBITDA) approach is important to determine the worth and health of businesses. It is defined as earnings before depreciation, taxes, interest, and amortization. It’s a measure of a business’s value through financial performance.
EBITDA can be calculated with the data on a balance sheet or income statement.
How to Value a Small Business
There are different ways to arrive at the value of a business. If you are looking to place your small business for sale, the ones we described above can help.
The right valuation method can depend on different factors. There are generally three different methods. You can include the ones listed above too.
- Assets after debt. This is a simple market approach to determine the worth of a business. Simply take the value of what a company owns and subtract what it owes.
- The SDE is another way to determine a business’s value. This is great for service companies. It focuses on an excellent income statement for strong valuation.
- The market comparison is another method used to arrive at a valuation. A business owner can use market research to compare what sells in their industry and location.
Any business valuation can use a combination of the methods listed above too.
How Much Does a Small Business Valuation Cost?
There’s a price range for a business valuation. A quick search says it costs between $2000 at the low-end to $30,000 at the other. There are several determining factors for a good valuation.
These include:
- The kind of records that are available. This can include geolocation data and paper records.
- The Industry. Some businesses have a liquidation value and more market information than others. Privacy rights can also be a factor in cost.
- The size of the company matters when valuing a business. More analysis is needed for bigger companies to get a good valuation.
Another method to arrive at cost is the age of the business. Established companies have better track records like product development numbers.
How to Value Goodwill when Buying a or Selling a Business
The most common method is to take the fair market value of the small businesses’ tangible assets. Subtract that from the entire business value. The features that go into goodwill can include the supplier list and a customer base. Patents, trademarks, and copyrights as well as permits and licenses are included.
How do I calculate the value of my business?
There are different tools. Facebook has an audience insight app that can give you information about purchasing habits and demographics. Audience Insights looks at your target audience.
Another approach is to use the seller’s discretionary earnings. This is the pretax income of any business.
How do you value a business quickly?
Here’s an approach to value a business quickly. Take your profit and growth trends to get a ballpark value of an enterprise. You can use an online and offline sales network to arrive at a number too. An expert in digital advertising can measure ad performance. You’ll want to measure content performance too. Google Analytics can help you look at your content profile.
Click-through rates are an excellent way to look at your ads profile. There are multiple ways to get the value of a business quickly. The discount rate helps to prevent you from underestimating risk.
How do you value a startup company?
The multiple business topics covered here include startups. Valuing one of these needs to include financial forecasts. Using comparables also helps. This means you should look at the value of other SMB’s in your industry and location.
A startup can have some unique features. Like the device characteristics used in a new eCommerce business. These are often important for a digital business that’s starting up.
How much is the average small business worth?
The average small business owner makes between $30,000 to $149,000 dollars a year. The average business revenue for an enterprise with no employees is $44,000 yearly. Other research points to the fact 80% of America’s small businesses don’t have employees.
These and some other factors affect their worth.
Image: Depositphotos
This article, “Business Valuation when Buying or Selling a Business” was first published on Small Business Trends
