Most business owners tend to avoid the topic, but every business will eventually transition. Tom Bronson, President of Mastery Partners, pointed out at the Retail Solutions Providers Association (RSPA) RetailNOW 2021, only about 72 percent of owners have an exit strategy. And unfortunately, only about 17 percent of businesses successfully transition – Bronson cited unrealistic expectations of enterprise value as the “number one deal-killer.”
But how can you know what your business is actually worth? Owners planning their exit strategies can use a variety of business valuation methods to land on a realistic number, for example:
- The Market Value Method
You’re probably familiar with this method if you’ve ever purchased property. Market value is based on comparable companies or “comps” – your business’ value would be based on similar businesses’ selling prices. However, the problem is that there isn’t always a record of the amounts buyers pay for businesses, so there may not be a comparable company sale on which to base your business value.
- Discounted Cash Flow Method
The discounted cash flow method bases business valuation on expected future cash flow. It takes into account leadership decisions, such as planned acquisitions and operating and capital expenditure patterns. This method has limitations – primarily because it’s based on estimations and projections. If circumstances change, the calculation could prove to be inaccurate.
Bronson pointed out that this may be a useful method for software developers: Google and Microsoft use this method, so if your company could be attractive to those enterprises, this may be the best method for your business valuation.
- Multiple of Revenue Method
If you are attracted to this business valuation method because of your revenue numbers, be aware that you need to look a little closer. This method only takes recurring revenue into account – buyers want revenues they can count on, preferably long-term.
The Most Common Business Valuation Method for Small Business: Multiple of Earnings
Bronson pointed out that the most common business valuation method – used in 97 percent of transitions for small businesses with earnings less than $100 million – is the Multiple of Earnings method.
Strategic CFO explains that this method usually involves multiplying earnings before interest, taxation, depreciation and amortization (EBITDA) by a multiplier. That multiplier is based on factors such as the company’s size, market share, how sales are distributed across your customer base, and even whether you have a formal contingency plan in the event that you can’t lead your business any longer.
Additional Factors that Impact Business Valuation
Keep in mind that your business valuation depends on more than those numbers. How attractive your business is to buyers is also a factor. For example, a company in a growth market that owns all of the intellectual property (IP) it uses will be more valuable to a buyer than a business in a declining market with business dependencies.
Also, to get the best possible valuation, make sure you have effective and repeatable processes in place. Buyers will also want to see well-kept records of your financials and your business data. Additionally, you need to show that you have a well-planned exit strategy that will make the transition to a new owner easier, improving that party’s ROI.
The Fool-Proof Business Valuation Method
If all of the variables that go into business valuation make it an estimate at best, you’re right. Choosing a business valuation method and doing the math will only return a ballpark figure for you and your potential successors.
“The only real way to determine business value,” Bronson commented, “is to have a willing buyer and a willing seller who agree on a price.”