What is My Business Worth? 4 Ways To Develop A Proper Business Valuation.

February 19, 2020
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Are you thinking about selling your business in order to retire or move onto a different business opportunity? You’ve put a lot of work into building up your business where it is today, so one of the toughest challenges is how to determine its value as a seller. Business valuation can be a tricky process.

It’s a lot like selling a house, only on a much bigger scale. It can be difficult to separate your emotional investments from the tangible factors that go into a proper business valuation. Every business is different and every buyer is different. There is a lot that needs to go into coming up with a proper value for your business, and then negotiating a fair deal with potential buyers.

The honest fact is that there really is no “one size fits all” formula for evaluating how much your business is actually worth. Ultimately, it will come down to what you are willing to sell it for and what a buyer is willing to pay. However, there are some smart valuation methods you can utilize to determine your starting point for negotiations.

Here are some of the factors we look at when helping our clients with business valuations at Illumination Wealth:

1. Profit Multiple

Many business valuations will use a profit multiplier method, which is exactly what it sounds like. Take your company’s adjusted net profit or EIBTDA (or a profit average over a multi-year period) and multiply it by a pre-determined multiple. Most small businesses will find a multiple of profit in the 3-5 times as a standard. Larger corporations may have multiples in the 7-12 of net profit in a business valuation. A lot of other factors such as growth rates, recurring revenue, competitive advantages, concentration of revenue can impact the multiple.

The buyer would look at the net profits and see the investment potential. Let’s say they buy your business for 4 times the annual net profit and the company maintains the same pace of profitability. They will recoup their investment within 4 years. Everything past that is profit for them. Of course, the challenge is figuring out the multiple for your business, which is different on a case-by-case basis depending on what the buyer is willing to pay.

2. Discounted Cash Flow

This approach is similar to the profit multiplier method, but a bit more complex. Discounted cash flow involves projecting the cash flow for your business for years in the future. You first look at your present cash flow and then project your future year cash flows, factoring in inflation, expected business growth, projected revenues and projected expenditures.

A discount rate (cost of equity) is then applied to each year’s figure to determine the net present value of the future profit. This is definitely a more complicated method than profit multiplication, but in the end may be a more accurate measurement of your business’s real value over the next several years.

3. Study the Comparables

Like pricing a house for sale, you have to study the comparables— companies in similar industries that have sold recently and have a known purchase value and associated profit multiple. This is not always the most effective method because it’s often like comparing apples and oranges. Every company is different. However, it can give you a baseline comparison and help you as part of your overall business valuation process.

4. Valuation of Net Assets

A different way of looking at business valuation is to look at the net value of your assets instead of the profits. Imagine if all the assets of your company were sold and all debts were paid, what would the physical value of your business be?

Figure out the resale value of all equipment, property, computers, product inventory, etc. (factoring in depreciation). Then subtract the liabilities such as debts and leases to determine the net asset value (or “book value”). This is a real nuts-and-bolts method of business valuation, but it makes sense when your company has a lot of tangible assets and limited long-term revenue potential.

As you can see, there are numerous methods you can use to determine the value of your business. It’s not an easy task and it make sense to work with an objective financial advisor who understands business and can help you maximize the value of your business as it relates to your financial independence.

For all your business and financial planning needs, you can count on the team at Illumination Wealth. We work with many entrepreneurs—from small business owners to top corporate business leaders—and can help with all aspects of financial planning, tax planning, business planning and estate planning. Contact us today to learn more about our services and to schedule a free 30-minute personal consultation with one of our top advisors.