Business Valuation Methods & Determining What Your Business is Worth
Whether you’re preparing for a sale or acquisition, seeking debt or equity financing, or evaluating other strategic business decisions, it’s helpful to have a good pulse on the value of your business. This is a number investors will look at when performing their due diligence, that lenders will look at for risk assessments, and that will help you analyze offers and opportunities.
There is no hard and fast rule for determining how much your business is worth, nor will different valuation methods or strategies yield a single, consistent answer. This is why valuation is said to be more of an art than a science.
Which Business Valuation Method Should I Use?
There are several valuation models that combine company assets, cash flow, risk, comparable, and more to determine the value of your business. The method you use is typically based on your company’s size, industry, and lifecycle stage.
Many investors or lending institutions will have their preferred valuation method and will use this when making decisions about providing funding for your business. However, you should always have your own valuation done as well. It can often be helpful to perform a ceiling and floor analysis of company value (lowest value and highest value) to use as a scale for analyzing offers.
The following are some of the most popular valuation methods to determine how much your business is worth:
1 – Value Company Assets
This is one of the most basic ways for valuing a business. The basis of this method is to look at what the business owns (such as equipment, inventory, buildings, patents), subtract liabilities, and value the business accordingly. The mindset is that since you’d have to buy similar assets to start a similar company from the ground up, the business is worth at least its asset value.
Even though this valuation method seems straightforward, there are still some variations in how to calculate assets. For instance, company assets can include only tangible assets, or can include intangible assets such as brand, reputation, recipes, and goodwill.
One of the flaws in this valuation methodology is that an asset-rich company may not necessarily be generating much revenue (or vice versa). If you’re going to choose this method to figure out how much your business is worth, make sure to also take into account the results from other valuation methods.
2 – Discounted Cash Flow (DCF)
In the discounted cash flow method of valuing a business, the buyer is estimating future cash flow and what it is worth to them today. Discounted cash flow considers how much money your business is likely to make in the foreseeable future, then considers the cost of capital and how stable and predictable that income is perceived to be.
The math for Discounted Cash Flow can be a little tricky, but it’s considered one of the most reliable methods of valuation. Read more about Discounted Cash Flow in this Investopedia article: https://www.investopedia.com/terms/d/dcf.asp
3 – EBITDA Valuation
Your EBITDA value gives you an idea of your profitability as well as your company’s current ability to pay off debts. EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” To use the EBITDA Valuation method, you will need to find recent comparable sales transactions in your industry. The appropriate multiple has a lot to do with your industry, revenue growth rates, gross profit and EBITDA margins and risk, etc. It is common to use a high and low multiple to provide a range for company valuation.
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4 – Risk-Based Valuation
Risk-based valuation is based on the factors that make your business more or less attractive, including:
- Sales and marketing risk
- Competition risk
- Reputation risk
- Social risk
- Technology risk
- Management risk
- Financing risk due to multiple rounds of funding
- Exit risk
- Economic risk
- Legislative/regulatory risk
- International/currency risk
- Labor risk
- Cap table risk
To turn these risks into valuation, they will be rated to the degree of risk each carries. This risk will then be quantified into a value. The risk valuation method is not a common one, but can be helpful for new businesses without historical performance.
5 – Comparables Analysis
In comparable analysis, you’re looking at the value of comparable companies that have recently sold. The challenge here is being able to compare apples to apples with a realistic comp. There are two main types of comp models: common market multiples which uses market comparables to compare an organization against similar companies, and similar market transactions where similar firms were bought out or acquired.
Determining how much your business is worth is an art as much as it is a science. It can often be valuable to determine a valuation range, then evaluating offers accordingly.
If you’d like more information about valuing your business, reach out to us by calling 801-804-5800 or by contacting us through our contact form.
About the Author:
Jerry Vance, Founder & Managing Partner
Jerry Vance is the founder and managing partner of Preferred CFO. With over 13 years of experience providing CFO consulting services to over 300 organizations, and 26 years in the financial industry, Jerry is Utah’s most experienced outsourced CFO.
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