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How Do I Value My Business?

Featured Best Practice on Valuation

28-slide PowerPoint presentation
For any business looking to engage in acquisition activity, it is critical to understand what your strategy is. Acquisition and investment is more than a financial exercise, there has to be a strategy intent as well. This document is in three main sections to help formulating an acquisition [read more]

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A business venture may mean different things to different people. For some, it’s a source of financial independence, while for others it’s a sentimental creation, an expression of their innate passion. For them, it’s a timeless and priceless venture that gives them a sense of pride in their accomplishments. So, when they ask, “how do I value my business,” the answer is often an emotional one going beyond numbers.

However, as per common reasoning, each business has a value that business owners should know. This is where business valuation comes into the picture. It is the process of calculating the economic value of a business organization by considering factors like the current market value of assets, company leadership, and estimated future earnings of the business. The process involves a step-by-step process and often requires the assistance of legal and finance professionals.

You may be asking, “why do I have to value my business?” Then you should know that business valuable furnishes useful information that can be used not only for planning an exit strategy but also for selling the business and raising funds. Potential buyers and venture capitalists wish to know the value of the business so as to calculate their ROI and make key decisions. So, knowing the worth of the business can greatly help in the successful negotiation of a deal.

What Are the Ways to Value My Business?

Now it’s time to answer the question “how do I value my business.” The value of a business depends on a number of factors, including its nature of operations, size, team, expected growth, and many more. Here are a few methods that can help business owners go about business valuation:

1. Considering the current balance sheet

One of the simplest ways for a business to know its worth is by reviewing its current balance sheet, which gives a clear view of all assets and liabilities. Here are key factors to consider:

  • Tangible assets, such as property/building, machinery and equipment, and inventory.
  • Intangible assets, such as patents, trademarks, brand recognition, and goodwill.
  • Business liabilities, such as accounts payable, bank loans, bonds, mortgages, and accrued expenses.
  • Financial metrics, such as business profitability, earning ratio, and cash flow, etc.

Having a clear understanding of these will help business owners determine the current economic standing of the enterprise and ultimately, it’s worth.

2. Calculating EBITDA and SDE

Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a valuable business metric that helps in gauging the financial health and cash-generating potential of an enterprise. On the other hand, the seller’s discretionary earnings (SDE) refers to the net income of a business before deducting the salary of business owners. Other discretionary and non-operating expenses of the business are added back for SDE calculation.

Generally, small businesses calculate SDE, while larger businesses calculate EBITDA to determine value. Some businesses even use gross annual sales of a minimum of $1 million as a benchmark for the difference between a small and larger business. However, there are no set rules for use cases of EBITDA and SDE. Industry-specific multiples often apply to both SDE and EBITDA methods of calculating the value of a business. These multiples may vary from industry to industry and are formed on the basis of industry history and trends.

3. Performing a comparable analysis

A comparable analysis is also known as “equity comps,” “trading multiples,” “public market multiples” or “peer group analysis.” It is essentially a relative valuation method where the business compares its current value to similar enterprises by reviewing their trading multiples, such as Price–earnings ratio (P/E), EV/EBITDA, and other business metrics. EBITDA multiples are most commonly used as a business valuation method.

The logic behind a comparable analysis is as follows: imagine Business X trades at a 10-times price-earnings ratio, while Business Y has earnings of $2.50 per share. So, company Y’s shares must be worth $25.00 per share provided the companies are similar in their attributes. A comparable analysis gives an observable numeric value for the business on the basis of the value of other companies. It’s in fact the most widely used valuation approach because they are easy to calculate.

On a side now, growth shares are also an effective mechanism that enables a business to incentivize senior management to drive growth in return for receiving some of the value of a company over and above set valuation hurdles.

4. Performing a DCF Analysis

Discounted Cash Flow (DCF) analysis is essentially an intrinsic value approach to determining a business’s worth. Analysts forecast the unlevered cash flow of a business for the future and discount it back to the present at the business’s Weighted Average Cost of Capital (WACC). This analysis is performed by creating a well-defined financial model in MS Excel, provided with a huge amount of financial data. It is a very detailed approach and requires accurate projections and assumptions.

Nonetheless, the time and effort required to create a DCF model will also result in an accurate business valuation. The model’s usefulness is seen in the way it allows analysts to estimate a business’s value on the basis of different circumstances and even conduct a sensitivity analysis. Larger businesses use the DCF value as a sum-of-the-parts analysis, modeling different business units individually and adding them together.

5. Performing a precedent transactions analysis

Last but not the least, a business can conduct a precedent transaction analysis to determine its value. This analysis is akin to a comparable analysis in the sense that it’s a kind of relative business valuation method. In this analysis, analysts compare the business in question to other businesses in the same industry that have recently been acquired or sold. The method, however, is less commonly used than comparable analysis or EBITDA multiples.

The analysis reveals transaction values which include the premium amount added the price for which the company was acquired or sold. These values are a business’ en bloc value, which is the value of all common shares of a business provided all the shares in question bear the same influence and rights. However, it’s important to note that these transaction values help with M&A transactions but they can easily become less indicative of the current market over time.

Conclusion

It’s a great idea to determine the worth of a business. The aforementioned methods can help businesses come up with the numbers they need. No matter which method they use, it’s important to update the calculation annually and hire a professional business appraiser to get the most accurate business valuation possible.

Excel workbook
This excel provides a DCF valuation template which is a valuation method where future cash flows are discounted to present value. The valuation approach is widely used within the investment banking and private equity industry.

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About Shane Avron

Shane Avron is a freelance writer, specializing in business, general management, enterprise software, and digital technologies. In addition to Flevy, Shane's articles have appeared in Huffington Post, Forbes Magazine, among other business journals.




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