Your business might mean the world to you, but how does the rest of the business world value it? Learning how to value a business involves calculating what your business is worth and how much you could potentially get for it should you ever sell. It factors in current liabilities, tangible and intangible assets, and the seller’s discretionary earnings (SDE).
Determining an accurate business value is important because it dictates how much your business is worth. You can have your business professionally evaluated, or you can value your business yourself by using three easy steps. Keep in mind that assessing your business on your own can be tricky and it might not represent the exact number you would sell for. But it can give you a good idea what your business is worth. This article teaches you how to value a small business.
One of the easiest ways to value a business is by using an online calculator. Again, this might not be able to give you an accurate number, but you’ll be in the ballpark if you need an estimate. Most online calculators are free to use and can be found by performing a Google search. You’ll need to input what type of business you have based on your industry, your current profit, and your current sales. Then the calculator will spit out an estimation of the value. You can also use the following three steps to help you determine the value of your business. The number will still be an estimate, but it will be closer to the actual value than a basic calculator. Either way, it’s important to at least get a ballpark value on your business so you know its worth. You can always use a professional business broker to get a more accurate estimation, but keep in mind that there will be a fee.
Here are the three steps you need to follow to determine the value of a business:
The first step in determining the value of a business is to recast or normalize the business’s earnings by getting a number called the seller’s discretionary earnings or SDE. The SDE indicates the business’s pre-tax profits before the owner’s compensation, non-cash expenses, interest income and expense, and one-time expenses that don’t usually continue in the future. Keep in mind that small businesses are required to report the expenses on their tax return, but they do so in a manner that will hopefully reduce their tax burden. In other words, they can claim several deductions to make their business income appear lower on their tax form. Because of this, you may underestimate how much profit a business really makes by using the income numbers on a business tax return.
On the other hand, the SDE gives you a much better understanding of the actual profit of the business. It does so by calculating how much money they business earnings would be if it were sold to a new buyer. This number is calculated by adding back in expenses that are listed on the tax return that aren’t necessarily essential for running the business. For example, this includes the business owner’s salary as well as any single expenses that won’t be repeated in the future. Other examples of factors that are added back into the business tax return net income and are needed to calculate the SDE are as follows:
- The total salary of all the business owners
- Leisure activities that are used on the company’s budget, such as business golf outings
- Any charitable donations the company makes
- Personal expenses that are put on the business account, such as purchasing a new personal vehicle
- All perks that the owners of the business received, such as personal travel or vehicle payments
- All one-time expenses that won’t be repeated in the future, such as settling a lawsuit
- Any business travel that is not needed to run the business
- All non-cash costs including amortization and depreciation
- The payroll of family members who don’t hold essential positions in the business
To make sure you take all of these factors into account, you can use an online worksheet to help you figure out the SDE. This can be done by performing a Google search for SDE worksheets and estimated business values. Download the worksheet to help you figure out the SDE. The following two steps are listed below.
In most cases, businesses sell for anywhere between one and four times their SDE. This is known as the SDE multiplier or sometimes just the multiplier. Finding businesses true SDE can be tricky because it varies depending on several factors, such as the company’s size, its tangible and intangible assets, the industry, the market risk, the owner risk, and many others. It helps to view the industry standard multiplier and the business multiplier as two different numbers. One will give you a general value based on industry averages and trends while the other will provide you with a much more specific value that is based on particular factors regarding the individual business. The two biggest factors that will influence a company’s SDE are the industry risk and the owner risk.
For example, if the individual business relies on its business owners, then it cannot easily be transferred to a new owner. Because of this, the businesses value will decrease. On the other hand, if you plan on selling your business and the industry or business is expected to grow in the future, then the SDE multiplier will increase. As always, if you want an exact number or SDE multiplier, then you may want to consult a professional broker to help you. If not, you can find a company’s SDE multiplier by looking at different media sites. Some websites provide multiples for industry trends based on cash flow and the business revenue that’s reported monthly.
The last step toward calculating your business’s value is to take into account the liabilities and business assets that aren’t estimated in the SDE. Small business owners tend to take the legal side of an asset sale, meaning that the person who buys the business also purchases the tangible and intangible assets that make the business tick. In most cases, the seller also keeps the liabilities, but this varies on a case by case basis.
Tangible assets are physical things that the business owns and can put a price on, such as real estate if the business owns property, any cash on hand, and accounts or receivables. Generally, tangible assets are not included in the SDE estimate. Instead, they need to be added to the value of the business separately if you are buying them from the seller. On the other hand, intangible assets are things that add value to the company but aren’t physical, such as a businesses trademarks, reputation, goodwill, and its customer service. Intangible assets are usually only sold if the tangible assets are also sold, and they need to be included in the SDE multiple estimate. Liabilities are obligations that the business has that it has to pay for in the future, such as debt. Lots of sales are lost when sellers are unwilling to keep the liabilities that they created in the first place as buyers do not want to take on this responsibility.
Selling an asset typically involves the seller paying off the business liabilities with the money he or she gets from the sale. But it can get tricky if there is an open line of credit that the facility needs to continue business operations. It helps for the buyer to know what the potential liabilities are before buying the business. You can find that information by running a business information report through one of the major credit bureaus, such as Dun & Bradstreet. Anyone can use this technology to purchase information on just about any company for a fee of $121.99. It will tell you the company’s current debt, any debt that is past due, and how often the business owner pays their suppliers on time. Keep in mind that this information may not tell you everything you need to know about the company’s liabilities, but it will give you a good idea of what you’re buying in to.
Now that you know how to value a business by yourself, it’s time to learn how to maximize your company’s value to get the largest amount possible before you sell. These tips can help you do that.
If you know you’re going to sell your business soon or in the future, then taking the steps now to plan ahead will help you make the transition smoothly. Prepare your business valuation as if you’re going to sell it. You can do this by getting a third party CPA to help with the books so that you can pay off your debt to make a clean sell. Paying off your debt will also increase the value of your business when you sell it. According to small business experts, not having your bookkeeping in order is the number one deal breaker when it comes to selling your business.
One problem with valuing a business by using an SDE multiple is that it encourages backward thinking. Keep looking at the future, even when valuing a business to sell. This will help you present a business to potential buyers that guarantees a bright and profitable future. In other words, don’t make dead-end decisions knowing that you’re going to sell the business one day. Keep the business going as if you were going to invest in it longer. This will keep your business looking competitive to buyers. It will also increase your multiplier as well. A buyer wants to know what problems or challenges the business will face in the future. If you limit these challenges for the next owner, then you’ll turn a better profit. You can inform your buyer by providing them with projections on how you set the business up to thrive in the future. Also provide them information regarding the worst case scenario so that you set the new business owner up for success, too. It will help the buyer understand what your intentions are for the business and will instill confidence that it will continue to perform well.
As the business owner of a small business, it’s your job to control how the public views your company before you try to sell it. As the saying goes, perception is reality. A business with loyal customers will be easier to sell than a business that struggles. It will also sell for more money knowing that business will continue as usual. In addition to building up your company’s reputation, you’ll also want to go over your promotional strategy. You wouldn’t sell your house without fixing it up first, so why sell your business without making it look more appealing?
Start by reviewing your website, sales material, business cards, and other areas that give your company a face to the public. Make sure all information is up to date and positively reflects your business. Take a little bit of extract time to make sure your promotional game is on point before you consider selling.
Putting all emotional attachment aside, determine if you need professional help by deciding how you’re going to value your business. You can do it on your own or with the assistance of attorneys and accountants. You can also hire a professional appraiser or broker. Keep in mind that the extra money you spend on getting a value professionally done may help you when it comes time to sell the business. Presenting a number to a potential buyer from a broker as opposed to your own calculations looks more professional and can help validate your asking price. Remember not to assume that you’re the only one who can run your business properly. If a buyer comes in with ideas that aren’t your own, consider them and try not to get too emotional.