November 19, 2019 | Last Updated on: July 12, 2023
The act of assigning a value to your small business (also called business valuation) is a key skill for any business owner. You’ll want to know the best ways to objectively calculate the value of your business for one or more of many reasons. But no matter why you need to know what your business is worth, the process should encompass multiple ways of valuation in order to be as accurate as possible when preparing for any possible scenario.
Perhaps the most obvious reason to establish your business worth is to prepare for selling your company. If potential buyers were to come to you, do you have an idea of the number at which you’d be willing to part with the company you’ve worked so hard to build?
If you’re looking to raise capital, you may decide that it’s time to seek outside investment. In order to provide possible investors with a fair price for any percentage of your company, you’ll need to be fully aware of what it’s worth overall.
Getting a business loan is essential for virtually every company. Some business loans will require a percentage of ownership in your company as collateral. In order to secure the funding you need to grow, expand, pivot, hire, or purchase new equipment, you’ll want to make sure that your business loan is for the right amount and from the right lender. Having an accurate valuation will help.
An unfortunate reality is that business assets are a consideration during divorce proceedings. In such a situation, it’ll be necessary to know what your company is worth as marital assets are divvied up.
Establishing the value of a company at set intervals can be an illuminating way of checking on its health. If a company is worth more now than it was a year ago, you can ask yourself what factors led to that growth. If the valuation has remained steady, you can pinpoint what’s holding back growth. You could even use the valuation to set value-based goals for your business in order to help drive growth.
There are as many different ways to establish the business’s value as there are businesses. But whether you’re looking to buy an existing company, sell your own business, or simply appraise a company, we can look at four of the most commonly used business valuation methods and determine which method is best in which contexts. These methods are the discounted cash flow method, the book method, the times multiplier method, and the market value method.
When determining the value of a business using the discounted cash flow method, the appraiser must examine the business’s balance sheet and project future earnings based on the available data. When using this method, the appraiser is essentially deciding how much the business’s probably future earnings are worth at the moment of appraisal. The discount of the future cash flow depends on several factors, not the least of which is the inherent risk of your particular industry, niche, or location. This method can be particularly helpful when establishing the value of a newer, growing business that may or may not be generating profit.
The book method of business valuation involves calculating the value of the business by using straight up asset valuation. First, the business owner calculates the value of all positive assets. That can include real estate, cash on hand, existing inventory, ongoing incoming accounts, and owner salary. You’ll also factor in the value of your equipment. Then liabilities are calculated. Taxes owed, existing debt, ongoing relationships with vendors, and business loans taken out in the company’s name. Finally, the liabilities are subtracted from the business’s assets, and the remaining number is the business value. The book method can be helpful when you’re looking to liquidate a business, because it leaves out a significant factor in any appraisal: income. The book method only looks at business assets and liabilities, making it particularly effective when you’re looking to buy, sell, or appraise a business that isn’t generating any revue. So while it can be a helpful tool, it has obvious limitations.
When determining the value of a business using the times revenue method, the appraiser will look at the company’s books for a year. Then that revenue is multiplied by a particular number depending several factors. When a company is growing and risks are determined to be low, the multiplier can be as high as 2 or more. When the company is fully liquidating, that multiplier may be .5. For a company holding steady, it’ll be close to 1. Whatever the multiplier may be, the business’s annual revenue is, logically, multiplied by that number to find a sale price. There are limitations to this valuation as well. For example, revenue is not the same as profit. So while a company could be generating large revenues, the times revenue method doesn’t factor in the idea that the company could also be spending a ton to generate that money.
One other way to form a valuation of a company is to use the market value method. To find a sale price using this method, do deep research into sales of comparable businesses in the area. What were they sold for? How similar is your company? This method works best with a larger data set. A one-time sale of a similar company isn’t enough information to work with. You’ll need to access the purchase price of as many companies as you can in order to establish a fair selling price.
Don’t forget that with any appraisal, there are intangible assets that will matter when it comes to finding an accurate number for your business’s value. Factors like a loyal existing customer base, a sterling reputation, prime location, trademarks, and intellectual property all matter. Particularly when you’re buying a company with a long-time footprint in its area, that existing customer base and reputation can be a huge factor in the sale price.
Small business owners seeking a fair market value in any appraisal would be wise to consider using a combination of valuation methods. You should have a firm grasp of the company’s assets and liabilities while also understanding its intangible assets and knowing what similar businesses have sold for in the recent past. You may find that the smartest course of action is to hire a business appraiser: a professional at determining the fair price of any company. But keep in mind taking the step of hiring a third-party professional can carry a cost in the thousands. Those valuations together will help you find a business’s worth in a way that will mean any sale, merger, or informational appraisal is as accurate and fair as possible.
