Valuing My Business

Valuing your Business is both a science and an art that blends financial analysis with a deep understanding of the market dynamics, competitive positioning, and growth opportunities of your business to arrive at an objective market value of your business.

Most valuations are usually conducted by third parties and/or a qualified Business Broker who go beyond just crunching numbers. Their analysis assesses the value of tangible assets, like property, equipment, and inventory, as well as intangible assets such as brand reputation, future customer and supplier relationships, and intellectual property, all of which best tell your business’s story.

Business valuations bring confidence and clarity to the financial decision–making process.

Whether you are a Seller or a Buyer, a third-party valuation adds credibility and clarity to the negotiation process. It provides strength to the negotiating process through logical reasoning, which allows one to feel good about the fairness of the purchase price and structure of the sale/purchase.

​​​​​​​The situations where an appropriate valuation becomes significant:

Purchase Price: Determines fair pricing for confident negotiations and deal terms.

Purchase Price Allocation: Distributes the purchase price of a sale or purchase across tangible and intangible assets, incurring the lowest possible tax ramification, and for both tax and financial reporting compliance

Tax Compliance: Establishes the fair market value of each asset being sold for accurate Estate Tax reporting, 409A Valuations as well as other regulatory compliance requirements.

Financial Reporting Compliance: Ensures assets are fairly represented under regulatory standards

Ownership Changes: Sets a clear price for partnership transitions

Legal Disputes: Provides an objective process and foundation for resolving any disagreements or settlements that may be necessary

Strategic Planning: Offers insights that help guide growth, investments, and resource allocation

Loans and/or raising Investment Funds: Demonstrates and supports the actual worth of the Business to attract Buyers, Investors or secure outside financing

Insurance Needs: Helps prove your Business's worth to use in determining appropriate Insurance coverage

A Business Valuation may be for a variety of different reasons, each of which may be suited to different circumstances and characteristics.

Generally, the methods used to value your Business will fall into three main categories: Income Based, Market Based, and Asset Based approaches.

Below is the Break-Down of the main approaches with their key valuation methods.

Asset–Based Approach:

Book Value Method: This value method calculates a company’s value based on its balance sheet by subtracting total liabilities from total assets. While this is a straightforward calculation, a company’s Book Value most likely will not fully reflect the company’s market value, especially in circumstances where there are intangible assets such as brand reputation and/or intellectual property, which have already been fully amortized or not recorded on the balance sheet.

Net Asset Value (NAV) Method: This approach calculates an up-to-date net worth of the company by adjusting the total assets and liabilities to reflect their current market value. It includes adjustments for both tangible assets, like property and equipment, and intangible assets such as intellectual property, provided their current market value can be reliably determined. This method, like the Book Value Method, may still not include important and valuable intangible factors like brand equity, or the competitive advantage your Business may have, which significantly impacts the value of your Business. While this method is more precise than purely the Book Value calculations, NAV relies on accurate market value estimates, which introduces some subjectivity to the process.

Liquidation Value Method: The Liquidation Valuation method estimates the amount of cash that could be realized if the Business’s assets were sold off immediately and its liabilities were paid in full. This method calculates the worst-case value. This method often values assets at lower values since they are sold off quickly, which typically requires a discount. This methodology is typically used by businesses facing bankruptcy or financial distress as it calculates the recovery from liquidation.

Replacement Cost Method: This method estimates the current cost of acquiring substitute assets with similar functionality. This approach is used for both tangible and intangible assets and is often applied to purchased intangibles like software or licenses, but it can be used for tangible assets such as equipment and buildings. This method. too, overlooks broader intangible factors such as brand reputation and/or current and future customer relationships, that influence the overall value of a business.

Reproduction Cost Method: This method estimates the cost of recreating all the tangible and intangible assets, as it was when formed or acquired. It includes all direct costs, such as labor and materials, and indirect costs, like loss of income during the reproduction period. This method is often used to value in-house developed intangible assets, such as custom software or proprietary systems, as well as intangible assets like specialized machinery or unique infrastructure.

Market-Based Approach

This approach is very similar to Residential Real Estate as it values the Business by comparing it to similar businesses that have sold and/or are available in the marketplace. It is MOST useful for companies with established revenue and financial history, as these factors allow for a meaningful market comparison. The following methods are typically applied under this approach.

Guideline Public Company (GPC) Method: This method values a private Business by analyzing valuation multiples of similar publicly traded companies. For accurate results, the valuation multiples must be determined by selecting public companies that closely match the subject Business or a similar industry, are similar in size, and have similar financial characteristics. The key multiples are used, such as price-to-sales or EBITA ratios. For example: To determine the earnings multiplier, you divide the market value per share by the earnings per share. So if a stock is worth $10 per share and earnings are $2 per share, the earnings multiplier would be 5. By multiplying the earnings of the Business by 5, one would value the Business (annual earnings x 5). The GPC Method is most reliable when a private Business has a stable revenue history with multiple years of reliable financial data. To arrive at the most accurate value, adjustments are made based on differences in size, risk, and any other relevant factors that may exist between the public companies and the subject Business.

Subject Business Transaction Method: This method, also known as Precedent Transaction Method, is a valuation approach that derives a Business’s value from its own recent financial activities, such as equity sales or capital raises. This is particularly useful when the Business has a history of recent capital raising events that reflect its market value to the capital investors.

Income-Based Approach

Earnings Multiplier Method: This method values a private Business by looking at the recent sales of similar private businesses and/or similar publicly traded companies. To determine the earnings multiplier, you divide the market value per share of a public company or the recent sales price of a private Business by the earnings per share, and/or the net annual earnings of the private Business that recently sold. If a stock is worth $10 per share and earnings are $2 per share, the earnings multiplier would be 5. By multiplying the earnings of the Business by 5, one would value the Business. If you know the sales price of a recent Business and know the income that the Business earned, divide the sales price of the business by the annual earnings. For example, if a similar Business sold for $3,000,000 and the annual net earnings were $600,000, the earning multiplier would be 5 ($3,000,000 divided by $500,000). Again, if you multiply the earnings of the Business by 5, it would give you the value of the Business.

Discounted Cash Flow (DCF) Method: This method estimates a Business’s value by projecting its future cash flows and discounting them to present value with a rate that reflects the business’s risk profile and the time value of money. By looking closely at the anticipated future earnings, one can determine if the current investment (purchase price) DCF offers a thorough look at the Business’s potential. The use of this method is particularly useful for companies with predictable cash flows. This prediction requires accurate assumptions about future revenue, expenses, and growth rates to produce the most accurate and reliable valuation. A DCF approach accounts for expected changes over time and provides flexibility for various financial scenarios.

If you are a small Business owner, the use of Seller’s Discretionary Earnings (SDE) Method is one of the best to use.

While the methods outlined above provide a solid framework for valuing different types of businesses, small business owners often need a tailored approach that considers personal finances, owner's current and future involvement, and variable cash flows.

​​​​​​​The SDE method calculates a business’s earnings by starting with EBITA (earnings before interest, taxes, depreciation, and amortization) and adding back the owner’s salary, ongoing personal benefits, and non-essential or one-time expenses. Many will subtract Cap X allocations (Cash cost of eventually replacing worn-out equipment) to arrive at the actual income. This adjustment provides a clear picture of the business’s true financial future performance from the new owner’s perspective. To arrive at the Business’s evaluation, the calculated SDE is multiplied by the factor derived from the comparable sales and/or the typical industry-specific multiple (typically 2-6), depending, of course, on various factors such as market conditions, the business’s growth potential and the perceived risk of owning the business. For instance, a business with an SDE of $400,000 and a reliable multiple of 3, would have a value of roughly $1,200,000. While the SDE Method is highly effective and accurate, combining it with other applicable valuation methods, like income-based or market-based approaches, can provide the most complete view of a business’s potential sales price

Intangible Factors that Affect the SDE multiple used and thus your Business Valuation

It's easy to assume that the Valuation of your particular business is just about tangibles, like equipment, revenue, and other assets, when actually, it's about all the intangible factors that make your business unique. The proper presentation of these factors ensures that the full story of your business is shared with prospective buyers, giving them the confidence to pay a premium for your business, recognizing the future potential your business offers.

For example, brand reputation and/or synergies may directly impact projected cash flows in the Discounted Cash Flow (DCF) analysis, while geographical location and/or future market conditions can influence both comparable business valuations and the SDE multiple to use in valuing your Business.

The factors that may influence your SDE multiple and thus your business valuation are:

Brand Reputation and Strategic Value: A strong brand and loyal customer base can significantly enhance your business’s value. These intangible assets signal trust, long-term stability, and future earning potential. This of course, will make your company more appealing to buyers and help justify a higher valuation.

Market Conditions and Risk Factors: External factors like market trends, economic stability, and competition heavily influence a business’s valuation. Strong market conditions and economic growth can raise a business’s value.

Age of the Business: A business’s age can affect its perceived value. Newer companies may lack a track record, but at the same time, offer high growth potential, while older established businesses often bring stability, reliability, a loyal customer base and reliability. These factors often justify a higher SDE and thus a higher valuation.

Valuation Circumstances: The context of the sale plays a major role in the business’s final valuation. A sale under the most favorable circumstances typically leads to the best outcomes. A forced sale or the liquidation of a business and/or its assets usually limits the business’s value.

Synergies Achieved: In the context of certain sales potential, synergies are achieved. Cost savings and/or revenue growth from combined operations for certain buyers can significantly raise a business’s sales price. Buyers are often willing to pay a premium if they foresee opportunities for added value beyond standalone operations.

Barriers to Entry: High barriers to entry, such as proprietary technology, exclusive manufacturing, and customer relationships, and/or significant capital requirements, make a business harder for someone to replicate. These competitive advantages enhance the value of your business by increasing buyer interest, leading to a buyer’s willingness to pay a premium.

Quality of Management: A highly skilled and visionary management team can be a key element in the sales price of your business. Strong leadership inspires confidence in the company’s future, thus making it more attractive to buyers, which often justifies a higher price.

Geographic Location: Location may play an important role in determining the value of your business to a buyer. Operating in a high-demand or strategic area can increase your business’s attractiveness. Being able to operate your business successfully in a different state with lower taxes might also justify a higher price.

Business Valuation Challenges

As you can imagine, valuing a business isn’t always straightforward. Below are a few challenges that can make the process tricky and ultimately impact accuracy.

Data Limitations: When a company can not provide or has detailed and/or consistent financial records, it is very hard to determine an accurate value. Sometimes. It's also challenging to find good data on similar companies to use as comparisons. This underscores the need to apply several methods tailored to a business’s specific circumstances and context to help assure the most accurate picture of value.

Goodwill and Intangible Assets: Goodwill, almost always, represents the additional value a buyer pays for a business above its tangible assets and liabilities. It is often linked to such factors as reputation, customer, and supplier relationships, and brand strength moving forward. Intangible assets, such as intellectual property and brand equity, also play a major role in a business’s overall value. Traditional methods, such as book value, often fail to capture these elements. For this reason, specific tailored approaches, like income-based or market-based valuation, provide a more effective evaluation of a business’s value.

Market Volatility: The ups and downs of the market can make valuation challenging, this is especially true for businesses that are in industries sensitive to economic shifts. Sudden changes in the economy can significantly impact the current value, which leads to higher or lower future earnings. This market volatility of earnings makes reliance on historic data risky because it does not represent an accurate picture to enable one to best value your business. While this past performance provides valuable context, it often overlooks changing markets and emerging risks,

Reliance on Assumptions

A proper valuation requires assessing a business’s growth potential, risk profile, and market dynamics, which almost always involves making assumptions about future performance. This requires analyzing factors such as revenue trends, current and future cost structures, competitive pressures, and the broader economic conditions. Because these variables can be unpredictable and/or outdated, one cannot rely on these assumptions or overly optimistic assumptions to determine an accurate value of your business. To ensure an accurate and thorough valuation of your business, it is important to revisit these assumptions periodically, including the latest market data, and adjust for any changes in your business’s unique circumstances or external environment.

It is never easy to determine what your business should sell for. Engaging the services of a business broker such as Established Business Opportunities is vital to selling your business at the highest possible price and doing so with the least amount of future financial and legal risks.