Understanding What Your Small Business is Worth
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For whatever reason, there is going to come a time when you need to understand how to evaluate your small business. You may be thinking of selling. Maybe you need to attract some investors, and potentially you might have to figure out some employee compensation plan; regardless of the reason, accurate valuation of your company is imperative.
However, how exactly do you do this? How do you figure out what your small business is worth relative to other small businesses in your industry? There are a few different ways that you can accomplish this—and you don’t necessarily have to be an accountant. Below are the basics to help you gain a clearer picture of what your company is worth.
Doing a Small Business Valuation
Again, whether you’re looking to sell or gain investors, knowing where your company stands as far as its value is going to be essential before you proceed with any such undertaking.
For argument’s sake, let’s say that you are considering selling and thus transferring ownership. The potential buyers are going to want to know the earnings they can expect from your business and the amount a share in the company is worth, among many other factors.
To this end, the buyer will consider the business’s value, and from that point, negotiations can take place. This is why having an accurate assessment is crucial. Not to mention, buyers are not going to want to invest unless they have the entire picture, and that picture, in turn, seems a substantial opportunity.
The methods outlined below represent fundamental ways in which you can arrive at a sound valuation of your small business.
Understanding where your assets stand concerning market value is one good way of approaching your company’s valuation. You need to gather the sum of all company assets and evaluate this in terms of current market worth.
What might your assets include, basically anything sellable, so for instance: vehicles, real estate, inventory, patents, digital accounts even. When doing this type of valuation keep in mind, there are one of two routes you can go. First off, you can proceed with the notion in mind that you will continue to operate. In this way, you can also value things such as reputation and projected cash flow.
On the other hand, if you view it in terms of a liquidation approach, the assumption is that the company will cease doing business, and so then, of course, things such as potential cash flow and regional standing matter little. This approach will bring a smaller dollar amount.
This approach may be among the easiest to grasp—especially for those who aren’t necessarily numbers people. Essentially you are comparing apples to apples; meaning, how does your business rate amongst your competitors. Look at companies of the same size and within the same industry that has recently sold—this should provide a good indication.
Yes, this is not as accurate as some of the other approaches, as different company structures can be difficult to compare. Not to mention, there has to be a number of similar small businesses in your region for this to work.
With this particular approach, you are assigning value based on what you expect potential future earnings for the company to be. If that is, the company has the potential to earn future revenue.
In an income-based valuation, something known as Capitalization of Earnings becomes a key factor. Simply put, this means that you divide discretionary cash flow (or the capital available that if used would not impact the business operations/) by the capitalization rate.
If this method sounds a bit complicated that’s because it is somewhat trickier to work with, especially for those who are not accountants; therefore, we recommended that you engage the assistance of such a professional if you are using this valuation approach.
Some Valuation Advice and What You Should Know
We understand that you have enough on your plate as it is without worrying about market values, income calculations, and asset reviews. So here is a breakdown of a few of the critical elements you need to know before trying to arrive at an accurate and meaningful company valuation.
Seller’s Discretionary Earnings (SDE/) come into play whenever doing a business valuation. A business’s SDE offers a general picture of what the company is truly worth. Unlike with EBITDA though, SDE will also factor the income and benefits of the company owner.
Smaller companies and startups most commonly utilize SDE. Whenever you are considering selling your business, calculating your SDE should be among one of the first things that you do as this number will need to be included.
Understanding Your Assets
Understanding your company value begins with understanding what assets you have and how much they are worth. While it may not be the most accurate valuation, at least it is a starting point that you can then use to consider your options.
Starting with a list is probably the best way to approach this. The list should have on it absolutely everything your business owns. This list should include all forms of assets from the tangible, to the intellectual, to any cash on hand. Leave no stone unturned when compiling this list. The more you include, the higher the value.
In tandem with this though, you do want to make a list of the company’s liabilities as well, as these will need to be subtracted from the assets. So things such as any outstanding loans, notes payable, credit card debt and the like.
Understanding the Market
This is where you want to do a little research and take stock of relevant companies in your regional market. You can quickly jump online and use a variety of sources to help gather this type of information.
What is Your SDE Multiplier?
Finding your SDE multiplier entails finding that number between 1 and 4 and consequently multiplying your SDE by this number. This, in turn, will show you what your company may be worth in a sale.
This is generally figured out by consulting with a professional and will be affected by factors such as the size of your business and the industry in which you operate.