Three Methods to Value a Business

If you are putting up a business for sale, whether in part or whole, it is important to understand how to value a company properly, so you can sell for the right price. Having an accurate price when it comes to your small business for sale puts you in a stronger negotiating position. The good news is that there are three basic methods for valuing your company.

Method 1: Market Value

This is a tried-and-true method of establishing the fair value of your company by comparing it to similar businesses that have sold in the past few years. There are several points of comparison that will need to be made which includes, but is not limited to the following;

  • Annual Volume
  • Number of Employees
  • Assets
  • Equipment
  • Market Share
  • Debts & Liabilities

Consider that businesses with an annual revenue of less than $1 may not have their information available to the public. In this case, you’ll want to contact a local business broker to help discover the information that you need.

Method 2: Assets Based

All businesses have assets and liabilities which makes it a sound way to assess the value of your business. However, the devil lies in the details since to figure an accurate number requires choosing the right standard for measurement.

First, if the owner did not pay for it, then it will not appear on any balance sheet. Plus, the balance sheet may not include important information such as internally produced products or the creation of proprietary methods. Also keep in mind products or services that were unique and not part of the normal business operations. Trying to assess the intangible value of products or methods may prove to be difficult.

Method 3: Earning Value

One common in how to value a company is to look at its earnings. Called the Seller’s Discretionary Earnings or SDE, this gives you a good idea of what the actual profit of a business is by calculating their net income, adding in expenses that are listed in their tax return which do not contribute to the company itself. This includes one-time expenses and the salary of the owner to provide a more accurate picture of the company’s potential revenue. In addition, there are a few other expenses as well, such as the salary of family members who will no longer be at the company, leisure activities, personal expenses, unnecessary business travel, donations to charity, and so forth.

This should provide you with the SDE number, so all you need is to use the multiplier that applies to your industry. There are variables, such as the size of the business, location, market and owner risk, and the tangible along with the intangible assets of the company itself. But, a typical business will sell for up to four times its SDE. This still requires valuing all assets and liabilities that are not included in the SDE, but that can be calculated to a reasonable degree. Keep in mind that the seller should retain the liabilities in this regard, so there might be some variation in the final number.

This form of evaluation is well-suited for businesses that earn less than $1 million annually and makes a good alternative to market value when some information is not readily available.

Calculating the SDE

A small business for sale can have its SDE number determined by calculating all tangible and intangible assets such as the following;

Tangible: This is the physical goods that can be valued easily, which includes the real estate itself, the cash on hand, and the accounts receivable. When making the purchase, be sure to calculate the intangible assets for the final price.

Intangible: These are non-physical products or goods that are valued for the business itself, such as the trademark, patents, reputation, and the goodwill that the company has built up over the years. You will need to put this number into the SDE.

Liabilities: These are the obligations that the business must pay today and into the future regardless of who owns the company. This is an important consideration because many buyers are unwilling to take on the liabilities of a company, especially if it outweighs the profit potential. In this case, the business may have to participate in an asset sale to pay off the liabilities which may leave little left. Continuing the business may be difficult, if not impossible depending on what remains and if it can be used to go forward.

Calculation: At this point, you can fill out your balance sheet and place the appropriate figures into their proper categories, then use the right formula to get the final results.

Add: Accounts/Receivable, Cash-on-Hand, Real Estate, and any other asset not in the SDE

Subtract: Liabilities

The result will be the estimated value of the business for sale. While it is still more of an art form, the more comparisons to actual sales you can make, the closer it will be to its proper value. It’s little wonder that the Earning Value Approach is arguably the most popular way to calculate the value of a small business for sale. However, it’s also common to use different methods to obtain a result that is fair and accurate. It will be up to you in setting a selling price to use the means that best reflects how to value a business in a way that is acceptable to buyers while retaining the proper value of your company.




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