Your small business is running successfully, and you’re on top of your performance numbers. The logical next question is: What’s your business worth?
While putting a single price tag on your company might sound complex, small-business valuation methods are definitive ways to determine your business’s value. As an entrepreneur, understanding the basics of how to value a small business will be helpful when you want to recruit new investors or sell the company.
Reasons to do a small-business valuation
There are many scenarios where you need to estimate the total value of your business.
- Raising funds: If you want to take out a business loan, or get investor funding for your startup, you’ll need to prove your company’s worth.
- Selling the business: Knowing the exact value of your business will help you negotiate the best deal with potential buyers.
- Going public: Business valuation helps you set a fair price for stocks if your company goes public.
- Creating a growth plan or exit strategy: Valuing your business helps you understand its growth potential or your exit strategy.
Plus, as Diana Mellion, PR specialist at BoardroomPR, a public relations agency, notes, “The valuation process will benchmark the business against others in the industry, giving you further insight into how your business operations stack up.”
How are small businesses valued?
You can value a small business before or after it starts generating revenue. Investors often do pre-revenue valuations based on factors like the merit of the business idea, the value of comparable businesses, and the industry.
For revenue-generating businesses, valuation can be based on actual financial data, like:
- Net assets
- Total revenue
- Seller's discretionary earnings (SDE)
- Earnings before interest, taxes, depreciation, and amortization (EBITDA)
How to do a small-business valuation
Add up the company’s assets
Assets are valuable things your business owns, like equipment and real estate. Doing an asset-based valuation involves subtracting your business’s liabilities, like loans and accounts payable, from its assets.
This method is helpful if you plan on selling the business, as a potential buyer will be interested in an asset-based business valuation if they intend to liquidate the business.
Consider intangible value
In addition to tangible assets like real estate, your business also has assets without a physical form. These intangible assets include:
- Patents, copyrights, and trademarks
- Brand reputation and customer base
- Brand assets, like logos and slogans
- Marketing assets, like an email list with 10k subscribers
A strong team or business idea is also an intangible asset. Imagine a supplement business that has well-known chemists on its research team. Investors will likely find more value in that company than one in the same industry that doesn’t employ trained scientists.
Analyze financial statements
How much money is your business generating? To determine that, you need accurate financial statements.
Your balance sheet will give you a list of assets, liabilities, and equity. The income statement shows how profitable your business is.
Also look at your business income tax returns. They will help you calculate financial metrics like seller’s discretionary earnings (SDE), and earnings before interest, taxes, depreciation, and amortization (EBITDA), which are essential for an income-based business valuation.
Research comparable businesses
The value of a small business varies based on industry. If you run a business in a high-demand sector, it will be worth more.
Researching comparable businesses, known as “comps,” is essential for some business valuation methods. It’s important to only compare companies similar in size, business model, and revenue to yours.
However, financial data of similar businesses isn’t always available. Try using tools like Crunchbase or AngelList to understand the state of startup funding in your industry. On top of that, search for the financial reports of public companies.
Small-business valuation methods
There are three main types of small-business valuation methods:
- Income-based valuation
- Market-based valuation
- Assets-based valuation
If your business hasn’t started making revenue yet, you can use startup valuation methods like Scorecard or Berkus.
Here are some widely used valuation methods for revenue-generating small businesses.
Market multiple method
This valuation method assumes similar businesses have a similar enterprise value. To start, determine the enterprise value of a business comparable to yours.
Enterprise value = Market capitalization + Outstanding debt - Cash and cash equivalents
The market capitalization (market cap) value is the total value of a company’s shares of stock. You calculate it by multiplying the price of a stock by how many outstanding shares the company has.
Now, determine the market multiple.
Market multiple = Enterprise value / Income metric
The income metric can be a company’s total sales, SDE, or EBITDA. Using the above formula, calculate the multiples of several comparable public businesses to get an average.
Now, multiply this value by your business’s total sales, SDE, or EBITDA to get your business’s worth.
Valuation = Income metric * Market multiple
For example, say a company’s market cap is $62.5B. The company has $400m in cash and cash equivalents. Its total debt is $10.4B, and its EBITDA is $4.36B.
Enterprise value = $62.5B + $10.4B - $400m
= $72.5B
Market multiple = $72.5B / $4.36B
= 16.6B
Now, if your company’s EBITDA is $5.76B:
Valuation = EBITDA * Market multiple
= $5.76B * 16.6B
= $95.62B
Adjusted net assets method
This method of small-business valuation uses assets and liabilities to determine a net value.
First, determine the value of your assets. You may start with the original price of the asset.
For example, to determine a pickup truck’s worth, start with its purchase price. A vehicle’s worth will probably depreciate over the years. So, calculate this depreciation value and subtract it from the original price.
Not all assets depreciate. For example, a plot of land in an ideal location can increase in value over the years.
Next, list the business’s liabilities, like loans, accounts payable, and mortgages. Adjust each to its current fair market value.
The adjusted net asset method is most suitable for capital-intensive companies. It will also help if you’re planning to sell your business. The drawback is that this method doesn’t consider a business’s revenue or future growth — for that, consider the next strategy.
Discounted cash flow method
This is an income-based valuation method that considers a business’s future cash flow.
First, predict the cash flow of your business for the next three to five years. You can create a cash flow forecast by taking the present cash flow and applying a growth rate. Next, calculate a discount rate to compensate for the uncertainty in predicting the future cash flow.
Use small-business interest rates as a quick stand-in for the discount rate. Alternatively, you can also use the weighted average cost of capital (WACC), which is the average percentage of return a shareholder will get in a year.
Use the discount rate to calculate a discounted cash flow. Here’s an example of the formula with a three-year forecast.
Discounted cash flow = cash flow year 1 / (1 + discount rate) + cash flow year 2 / (1 + discount rate)2 + cash flow year 3 / (1 + discount rate)3
If you take this discounted cash flow and subtract your initial investment in the business, you’ll land at your net cash value.
Net cash value = discounted cash flow - initial investment
For example, say that during the next three years of your business, you’re forecasting a cash flow of $20k, then $40k, then $60k. Also, you’re using a discount rate of 6%.
DCF = $20k / (1 + .06) + $40k / (1 + .06)2 + $60k / (1 +.06)3
= $20k / 1.06 + $40k / 1.12 + $60k / 1.19
= $18,867.92 + $35,714.29 + $50,420.17
= $105,002.38
Assume an initial investment of $30k.
Net cash value = $105,002.38 - $30k
= $75,002.38
Multiple of earnings method
In this method, you’ll calculate the business’s earnings, then apply a multiple to get the value of the business. The multiple is based on factors like:
- Business domain
- Company’s age and reputation
- Location of business
- Company assets
- Market risks
Use online sources to find multiples for various industries.
As with the market multiple method, you’ll also need to find earning metrics like net earnings, revenue, EBITDA, or SDE.
Total value = earning metric * multiple
Here’s an example of how to value a small business using the multiple of earnings method. Say your business has a net income of $30k, after subtracting all costs.
If you have a multiple of 12 based on your industry and other factors, then:
Business value = $30k * 12
= $360k
While it’s possible to value your business by yourself, getting an appraiser is a good idea.
Alex Lerch, marketing director at Oak & Stone Capital Advisors, a membership community of financial advisors, suggests, “When selecting an appraiser, verify their qualifications and experience in valuing small businesses. Clearly communicate the purpose of the valuation and the specific information you require from the appraiser.”
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