Business Valuation Methods
Getting a business valuation is the best, most effective way to answer the age-old question of “how much is my business worth?”
When you need to make a serious decision about your business, whether you are selling it, settling a dispute, planning for a merger, or restructuring, a business valuation is necessary. To accurately value your business, a valuator will assess different aspects of its operations, capital, and revenue.
That said, there are various approaches that a business brokerage or business valuator can take to appraise your business. There are standard valuation methodologies every broker will use, but some less common methods can help appraise more unconventionally structured companies.
When you work with Beacon Advisors, our business valuators will work closely with you to understand your needs and your business’s industry and goals. By working closely with you, we will identify the best business valuation method to assess your business’s overall value.
How Much Is My Business Worth?
“How much is my company worth?” is a question that many business owners would like the answer to, and rightfully so. After all, your business’s value is one of the main factors determining your business’s selling price.
Key Value Drivers
When valuing a company, it is essential to assess its potential to generate future profits. Businesses with high growth potential and positive industry outlook will trade at higher multiples, as buyers are more willing to offer a premium for future profits. Additionally, a company with a lean cost structure or low owner dependence are considered more desirable.
Another factor that determines a company’s valuation is its economic moat. A company with a low threat from competition and high entry barriers is perceived to have a lower risk.
Other factors that might impact valuation include pending litigation, management experience, revenue concentration, client base and supply chain. While valuing a company, experts will account for all these factors to accurately value a company:
- Future industry & business outlook
- Management & employee base
- Dependence on clients or suppliers
- Longevity & stickiness of its business model
The 4 Most Common Business Valuation Methods
Several different methods are used to value a business and set expectations for an owner, but four are most common. There is also a wide variety of factors that determine which of the four methods is used including, industry, annual revenue, annual net earnings and assets on the balance sheet.
Multiple of Earnings
The Multiple of Earnings approach, also known as the time revenue method or income approach, is the means of valuing a business based on its earnings. This method uses a company’s current profits to identify its future earning potential.
When utilizing this approach, business owners and investors might often come across multiples like EV/ EBITDA or EV/ SDE. These metrics estimate a company’s value based on its operating profit. An EV/EBITDA multiple of 3.0x means that if a company generates $100,000 in EBITDA, the value of the entire company is $300,000.
A company’s most recent annual cash flow is usually the best indicator of its performance. However, to create the most accurate and realistic projection for a potential new owner, a weighted Sales, Gross Profit, SDE, and Projected SDE based on a company’s historical and proforma Income Statements are created.
Industry-specific formulas, multiples, and performance metrics are taken into account to get an accurate valuation. The Multiple of Earnings approach is commonly used to evaluate small businesses.
Multiple of Revenue
Multiple of Revenue is the method of valuing a company as a multiple of its aggregate annual sales. If a company’s Enterprise Value/ Revenue multiple is 1.5x revenue and generates $1 million in annual revenue, it is worth $1.5 million based on this approach.
Net Book Value
Net Book Value is an asset’s value as recorded on the company’s balance sheet after accounting for depreciation and other accounting charges. The net-book value of a depreciable asset decreases over time. This value is not the same as the fair market value or replacement cost of the asset, and the fair market value of the asset might be worth more than its net book value.
Discounted Cash Flow
Discounted cash flow, also known as DCF, is a valuation methodology that determines a company’s value based on the present value of future cash flows. The future cash flows are discounted based on the company’s weighted average cost of capital. This method is a measure of the overall risk of the company’s operations.
DCF is an intrinsic valuation method and depends on the accuracy of model assumptions. The DCF method of business valuing is partially suited to businesses that don’t expect consistent future profits. It requires the business valuator to thoroughly research, understand, and analyze the critical valuation and forecast variables (both internal and external) that affect the valued business.
DCF analysis uses future free cash flow projections and discounts them to arrive at a present value, which is used to evaluate a company’s potential. If the net present value arrived at through DCF analysis is higher than the investment’s initial capital expenditure, the opportunity will yield a net benefit.
Despite the complexity of the calculations involved, this type of analysis aims to estimate the money that would be received from an investment and adjust for the time value of money. DCF is merely a mechanical valuation tool, and small changes in inputs can result in significant changes in a company’s value.
Instead of projecting the cash flows indefinitely, the future free cash flows are usually calculated for 3-5 years, depending upon the industry. A company’s terminal value is calculated and included in the valuation to account for its value at the end of the forecast timeframe.
Other Business Valuation Methods
Business valuation methods play an essential role in helping determine what your business will sell for. It is important to note that there are other factors at play that can increase or decrease the final price you receive. These factors include market forces and the willingness of the buyer and seller to complete the transaction.
Market Value Valuations
A market value business valuation, also known as a “comparable analysis,” is the most subjective approach to assessing a business’s value. It values your business based on how much similar companies have recently sold for. This methodology is based on the principle of substitution, which means that a buyer will pay no more than the price required to purchase an equally desirable substitute. It determines commonalities between companies by comparing critical financial and business characteristics.
There are two ways to go about this. If you are valuing a franchise is, then the cost to start-up another franchise is calculated. If this is not the case, then an assessment of comparable companies is made. The valuation considers the franchise fee, required inventory, leaseholds, royalties, invested capital (i.e. computers, furniture, machinery, equipment, etc.), and additional start-up costs (i.e. marketing, staffing costs, utilities, etc.)
Since the valued company is already established, it is necessary to account for the projected sales, cash flow, and excess working capital that the company has already obtained on top of the comparable franchise estimated start-up costs.
If there is no similar franchise to compare the company against, it is necessary to compare it against similar existing companies within the industry. The typical business factors considered are products or services, industry, location, distribution channels, and customers and end markets. The usual financial factors considered are size, profitability, growth possibilities, return on investment, and credit profile.
This method is best suited to businesses with substantial market data on their competition and is often used to display business value to potential investors. Often, this means of valuation is a great starting point but will require another approach to provide more exact data.
Asset-based valuations measure the value of a business by assessing the value of its assets. Of course, this method is best suited to companies with substantial assets like equipment, property, etc., that they can leverage. This business valuation method decides your business value based on its total net asset value (save for its liabilities) and has two approaches.
Businesses looking to continue operations and not go through the liquidation process will take what’s called a “going-concern” approach. This approach assesses our assets (your current total equity), minus any liabilities.
However, businesses looking to cease operations will opt for a liquidation value asset-based method that will evaluate the expected funds business will earn from selling their assets. This approach can sometimes lead to a lower value, as liquidated assets’ cost will often be less than fair market value.
As its name suggests, an ROI-based business valuation assesses a business’s value based on its profits and the return of investments an investor could stand to earn in the coming years. While this method is an excellent way for business buyers to identify how much they stand to gain from acquiring a business, this method is heavily based on current market values.
Capitalization of Earnings Valuations
Similar to the Multiples of Earnings Approach, the Capitalization of Earnings Method values a business’s future profitability by assessing its annual ROI and overall cash flow. This method is best for stable companies with consistent returns on investments, as it allows for a safer future prediction of future values.
Finding the Best Business Valuation Method for Your Business
There are different business valuing methods, but there is no one-size-fits-all business valuation solution. Companies are in various industries and vary in size, scope, and revenue.
Consider the factors that will help you identify the best business valuation method for your individual business needs. The good news is that you can use a balance of multiple approaches to value your business.
What industry is your business in? Whether you are looking to value a car dealership, value a construction company, or value a data collection company, the means of valuation will vary. Your industry directly relates to the type of assets it may have and its ability to achieve stability.
Your Stream of Revenue
Do you have a consistent or varied stream of revenue? The stability of your finances will determine the best ways to value your business.
Some businesses may have more assets than others because of the length of time they have been operating and their business’s general nature. For example, a manufacturing business with expensive equipment will have more assets than a marketing business.
Contact Beacon Advisors today to book your initial consultation.
We will work with you to identify the best approach for valuing your business.