Basics of Business Valuation

One of the first steps anyone should take when either considering selling their business, or analyzing a potential business to buy, is to understand what the business is worth.

While your own personal calculations shouldn’t take the place of a professional valuations, it’s helpful to get an idea of what the value is before making the decision to spend the time and money to hire a professional to provide an opinion of value.

You can do this by understanding the basic concepts of business valuation to determine if it’s in the range you need it to be to either start the process of selling your business, or to begin the process of purchasing a particular business.

Here you will see the various methods commonly used in valuating a small business and the steps involved in doing so.

  • Multiple of Earnings
    • A multiple is a number that is multiplied by a business’s profit to determine the value of the business.
    • Multiples vary based on the industry, geographic location, and sales volume.
    • Multiple of SDE
      • Sellers Discretionary Earnings (SDE) is the total income the owner of a business receives. This includes any owner salary, benefits, perks, and business profit
        • Multiples of SDE for small businesses usually range from 1.75 and 3.
        • To find out the average multiple for your industry and business size, check out our Current Business Multiples Resource.
    • Multiple of EBITDA
      • Earnings Before Interest Tax Depreciation and Amortization (EBITDA) is the business’s profit after paying an owner’s salary
        • EBITDA is typically used for larger businesses, businesses that are ran by somebody besides the owner, and businesses that a potential buyer plans on hiring somebody else to run
        • Multiples of EBITDA typically range between 2.4 and 4. Businesses with sales over $5,000,000 often have higher multiples
        • To find out the average multiple for your industry and business size, check out our Current Business Multiples Resource.
  • Percentage of revenue
    • A simplified method of determine business value
    • The percentage of revenue used to determine the value of a business varies significantly between industries.
      • This percentage can be anywhere from 20% to 150% or more.
      • You can check out our Resource Guide for typical percentage of revenues for your industry and business size.
  • Asset Value
    • Some businesses are valued solely on the fair market value of their assets
      • Assets may be real estate, equipment, inventory, patents, accounts receivable, etc
      • This method is often used for businesses that generate little to no profit, and businesses that require a lot of assets to operate.
  • Combined Methods
    • It is often necessary to use more than one method and determine a weighted average.
    • Different methods will sometimes produce drastically different results.
      • It’s best to consider which method(s) is most relevant to the specific business.

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