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How To Determine What Your Business Is Worth

Chase Busenbark

As a business broker, I understand that most business owners looking to sell as a going concern are simply looking for a quick way to determine the fair market value of their businesses.

They are not interested in calculating the terminal value, weighted average cost of capital or discounted future cash flow of earnings. Small business owners don’t need or even want to make it that complicated; they just want to get a rough idea of how valuations work and how they can determine what their company is worth using “back of the napkin” math, not complicated and fancy Excel formulas.

So, skipping all the complicated finance theory that isn’t relevant to most main street business owners, let’s quickly determine how much your business is worth.

When it comes to business valuations, think AIM: asset method, income method or market method. We will focus on the market method primarily, but I’ll first mention how the other two methods work.

Asset Method: This method is simply calculated by taking the difference between business assets and liabilities. For example, if you have $100,000 in assets and $20,000 in liabilities, the value of your business is $80,000 ($100,000 – $20,000 = $80,000). Typically, this is not the valuation method you want to use if you have a profitable going concern business.

Income Method: This method is a favorite for financial wizards and professors who love teaching theory. It’s not easy for most small business owners to understand, let alone calculate. In short, you have to determine the business’s future economic benefit (forecasting financials), adjusting for growth rates, cost structure, taxes, working capital, etc., and then discount that future economic benefit to a present value. It involves discount rates, discounted cash flow calculations or capitalization of earnings. Honestly, I feel tired and confused just explaining how it works.

Market Method: Let’s focus our time and effort on this method. It’s quick and easy to understand, and you’ll know within five minutes what your business is worth (or at least a general range). The basic premise is to look at what companies similar to yours in size, revenue and other characteristics have successfully sold for. The value of your business is tied to that value.

Let me give you an easy example. Once you understand the math, you can apply this to your own business. According to data, average cash-flowing businesses sold for 2.28 times seller’s discretionary earnings (SDE).

First, let’s tackle what SDE is. If your profit and loss statement shows that you have a net profit of $100,000, you need to “add back” a couple of items. This includes any personal, discretionary and one-time expenses, as well as one owner’s salary.

Let’s assume you have a salary of $50,000 per year. Following the advice of your CPA to lower your taxable income, you use the business to pay for your family health insurance, auto, gas and auto insurance. You also have some depreciation and interest, as well as retirement contributions. Let’s assume all those expenses add up to another $50,000.

Here is what the math looks like:

  • Net profit: $100,000
  • Owner salary: $50,000
  • Add-back expenses: $50,000 (these must be documented and justified)
  • SDE: $200,000 ($100,000 + $50,000 + $50,000)

Now for the valuation:

  • SDE: $200,000
  • Market multiple: 2.28
  • Fair market valuation: $456,000 ($200,000 x 2.28)

There you have it. All you need to do to quickly determine the value of your business is to calculate SDE and multiply it by the average market multiple for your industry.

It’s key to determine what your market multiple is, and having access to successfully completed transactions is vital in this research. You’ll likely need to see a business broker who has the certified business intermediary (CBI) designation, or a mergers and acquisition specialist. Both of these professionals can look up the average market multiple for your industry and adjust it up or down based on the individual characteristics of your company and circumstance. A lot of training and professional standards go into determining this, so when the time is right to list and sell your business, don’t rely on 2.28 just because it’s the market average. Consider seeking out a professional to get detailed help.

Once you know how much your company is worth, you can then determine if it’s time to sell your business and cash out now, or continue building for an increased future valuation.

Here is the fun part: Using the example above, your business is worth $456,000, but you really want to sell it for $750,000. Just work the numbers backward, and you’ll know exactly what you have to show in annual SDE to justify a $750,000 valuation.

Here is what the math looks like:

  • Goal sales price: $750,000 divided by 2.28 = $328,947
  • Current SDE: $200,000
  • Goal SDE: $328,947

Over the coming years, work at getting your company’s annual SDE to increase by $128,947, and you’ll justify your $750,000 valuation.

 

Chase Busenbark is a native of Southeast Missouri and comes from a family of business owners and employers in the region. Chase earned a bachelor’s degree in business and has been actively involved in his family business from a young age. His participation in the planning and implementation of business infrastructure, contracting, accounting, sales management, and business development activities provided him with a diverse set of skills. He has done everything a business owner would do for a 100-person company and can apply this experience to business brokerage.