Business Valuation

It is very easy to find an estimated value of a home in the U.S. but with 28 million small businesses, majority do not know what their business is worth. The question is, does a business truly need a valuation to know what it is worth? Research indicates that many small business owners are less likely to have diversified investments and count on the sale proceeds of their businesses as their retirement income. If this is true, then is it not a good idea to realistically know what one's business is worth?

Reasons when a business needs valuation -

  • Estate settlement
  • Income tax and property tax disputes
  • Litigation
  • Divorce
  • Mergers and acquisitions
  • Bankruptcy
  • ESOP
  • Gifting of minority stock interests

Accurately valuing a small business is like forecasting the weather. Therefore business valuation can be seen as an art, not a science. Most small businesses typically sell for a multiple of their earnings. However this is very subjective. The most effective number to aid in the calculation is total owner benefits. This generally includes the salary an owner pays himself/herself, the profits paid to the owner from the business and other perks paid to the owner (Such as payments towards owner's car). Other non-cash expenses are added back (Depreciation) to this number.

Most small businesses sell in 1-3 times their multiple. Some sell for more and others for less. Typically, professional businesses such as doctors, lawyers, accountants etc. would sell for a lower multiple as their businesses are closely tied to the professionals. Whereas businesses with a good track record, growth pattern, intellectual property, exclusive territory etc. would sell for a higher multiple. Most others would fall somewhere in between.

There are various valuations methods used to calculate business value –

  • Asset Valuations: Calculates the value of the assets of a business. Does not typically work for small business valuations
  • Liquidation Value: Determines the value of the company’s assets if it were forced to sell all of them in a short period of time (usually less than 12 months) 
  • Income Capitalization: Future income is calculated based upon historical data and other assumptions. Applies mostly to larger businesses
  • Income Multiple: The net income (profit/owner's benefit/seller's cash flow) of a business is subject to a certain multiple to arrive at a selling price. Most commonly used by small businesses
  • Rules Of Thumb: The selling price of other “like” businesses is used as a multiple of cash flow or a percentage of revenue