How to Determine How Much Your Business Is Worth
To determine how much your business is worth, first choose your method of measurement. Choose the best method for your company based on your size, industry, and lifecycle stage. These methods of business valuation use different combinations of metrics such as tangible company assets, expected cash flow, associated risk, and comparables. There is no single method or final dollar amount that is “right,” which is why valuation is said to be more of an art than a science. It can sometimes be useful to do a ceiling and floor analysis of company value (lowest value and highest value) to use as a scale for analyzing offers.
The following article discusses 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 systems 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 likely worth at least its asset value. This can include only tangible assets or can get more complicated when including intangible assets such as brand, reputation, recipes, or 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 books into account.
2 – Multiples of Revenue
In the multiples of revenue method (also called the Times Revenue Method), you calculate the revenues over a certain period of time. The period of time (the multiplier) is usually determined based on industry. This method is often used in young companies or companies poised for speedy growth.
In general, the multiples of revenue method of valuation is considered an unreliable indicator of the value of your business since revenue does not necessarily mean profit.
3 – 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 Cach Flow in this Investopedia article: https://www.investopedia.com/terms/d/dcf.asp
4 – 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 EBITDA to provide an EBITDA Valuation, you will multiply your EBITDA by a multiple. This multiple is often based on recent comparable sales transactions in your industry. It is also common to receive a high and low multiple to provide a range for end-user valuation.
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5 – 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, and then quantify that analysis into value.
6 – 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 find a reasonable comp to prevent comparing apples to oranges. 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: Contact.
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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