Small Business Valuation
If you’re considering selling your business the first step is often to determine what your business is worth, or what it would likely sell for in today’s market. Knowing the value of your business should help you determine if now is the right time to sell. There are a number of methods used in determine what a business is worth and often times a combination of methods will be used. The method used to value your business is dependent on the industry, the condition of your business and other factors. Our goal here is to give you an idea of what your business may be worth by showing you what some of the methods of valuation are. Let’s look at some methods below...
This approach to valuation is the most basic form of determining a business’s value. This method is simply determining the current fair market value of all of the business’s assets such as equipment, real estate, etc. If you were to just close up your business today and sell everything, this is what you would get. This approach doesn’t take into consideration the goodwill of the business or its ability to generate income in the future. This approach is often used for a struggling business that has little or no profit.
This approach takes into consideration the amount of income the business has previously produced is producing and its likelihood to continue producing. This is the approach in which a buyer will determine what kind of return they will get on their investment in the business and the risk they’re taking. Since purchasing a business is typically a larger risk than investment real estate or other securities, and involves more risk, the buyer is going to be looking for a higher return on their investment. Of course, there are different approaches to this approach. Again, the approach used will depend on the condition and industry of the business.
These approaches will all use a multiple of earnings. A multiple of earnings is when the earnings are multiplied by a given number (the multiple). Smaller businesses with an owner that’s very active in the business will typically use a multiple of SDE (Seller’s discretionary earnings). SDE is the amount of money an owner makes from the business. If the owner is collecting a salary it is the salary plus profit plus owner benefits. Larger businesses or businesses where the owner is less active will typically use a multiple of EBITDA (earnings before interest, tax, depreciation, and amortization). This method doesn’t add the owner’s salary to the multiple, but is often given a higher multiple. The multiple used in either of these approaches will vary depending on the current market condition, industry, and business size. In most cases, the more profit a business has the higher the multiple will be since it’s a less risky investment.
Following are some general rules of thumb. These rules of thumb may or may not be the case for your business but should give you an idea of what range your business value will be in. Small businesses with earnings of $1 million or less will typically use a multiple of SDE. That multiple may be between 1.5x and 3x. In most cases the value will be between 2x and 2.5x SDE. Businesses that have earnings of over $1 million will usually be based on a multiple of EBITDA. That multiple will usually be between 4x and 6x.
Exactly which multiple is used will depend on a number of factors. The valuator will look at recent business sales in the same industry and similar market. They will also look at the direction in which your business is trending. Have sales and profits been increasing the past three years, or declining? The better future projections your business has the better valuation you will get.
The value of the assets is often not included in the value of the business when using the income approach because the assets are a required piece of the business in order to earn the income it produces. However, in some cases the two approaches will be combined depending on the ratio of the value of assets to the value of the future income. In this instance they will usually use a lower multiple and add that to the value of the assets.
Hopefully this information was helpful in giving you an idea of what your business may sell for in today’s market. Keep in mind, just like any other market, these values are a moving target. It’s best to time the sale of your business when the market is strong. With the quickly growing number of baby boomers retiring in the coming years there will be an influx of businesses going up for sale without enough buyers ready to purchase them. Just like anything else, when supply is higher than demand the values tend to drop.
If you’re serious about wanting to sell your business and want to see if now is the time to do it, let Vandenboss Group provide you with a Value Opinion at no cost. Provide some basic information below and we will reserve time with one of our business valuation experts for you right away.