How to Value a Business

What is the real market value of the business you want to buy or sell?

In TIPS on Selling a Business and TIPS on Buying a Business on this site we’ve covered a lot of the variables – different methods of valuation and how they can be applied and cross-checked but on top of this is our own long experience and data base of information on all the businesses we’ve sold here over 19 years, which is really critical in making the final call on what the business should be sold for. Briefly the other material says:

There are a number of standard methods used to value a business but it’s vital that different valuation methods are each taken into account when calculating the true value of business.

Each one of these methods individually does not always represent the true value of a business. We have seen valuations where the derived value of these five different approaches varied by several hundred percent!

For example, there are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work.

However most businesses today are valued as a multiple of SDE (sellers discretionary earnings) with the base multiple varying by industry. SDE is the sum of taxable income before interest, income tax, depreciation and amortisation, which gives EBITDA (earnings before interest, taxes and amortisation). EBITDA is then added the owner’s benefits and discretionary expenses charged to the business like salary, write-off of company car, health insurance, holidays etc which gets us to the true SDE – which is usually far higher than the company’s taxable income.

Most businesses are valued at a multiple of SDE with the multiple varying by industry. We weigh all these factors and adjust the multiple up or down based on our practical experience here. Examples of factors that will value the multiple up are: increasing sales, margins and profits, repeat/referral customers, location, the seller’s willingness to carry a seller note and the business’ upside potential. Examples of factors that will value the multiple down are: declining revenue, margins and/or net, customer concentration, competitive threats, short time in business and an above market facility lease rate.