How do you put a value on your business?
There are a myriad of reasons why a business owner may need to value their company. These could range from the purchase of business insurance for business continuity, the application of a business loan, and a potential sale of the business.
So how can you – as a business owner – figure out how much your business is worth? (That is, before you approach a professional accountant for help.)
1. Asset-based Valuation
The easiest way to value your business is by using an asset based valuation. In this approach, your business liabilities or debt are subtracted from your assets. For example, if you are in the landscaping business, then you would have to calculate the resale value of the equipment and vehicles held by the business. The liabilities or debt to be paid off will need to be subtracted from the resale value of these assets.
What this means, is that you are looking for the a liquidation value of your business. This is not a popular method as it completely ignores the goodwill of the business.
2. Profit multiple
Another method would be to value your business as a multiple of its EBITDA. What happens here is that future cash flows are estimated for the business and a multiple is assigned to it. If your company has $2 million revenue annually and EBITDA of $200,000, assuming a 5 times EBITDA multiple, then the value of your business would be $1 million.
By this calculation, the price an investor pays to buy your business is determined by the return they expect to get. Similarly, revenue multiples, industry multiples, and cash-flow multiples can also be used in the calculation.
How is the multiple decided?
The multiple is dependent on the industry that the business operates in and the nature of the business.
3. Discounted Cash flow
In this method, your business’ future cash flows are calculated and then the cash flows are discounted using a weighted average cost of capital to arrive at a present value. If the estimated value is higher than the amount that the business is about to be sold for, then the business would be worth investing in. Many prominent investors such as Warren Buffet use this method to arrive at an investing decision.
There are many variations which cane used when estimating the cash flows and the discount rate. The logic behind this valuation is that an investor investing putting their money into your business is forgoing the interest or gains that they could have earned if the money was saved or invested elsewhere. Also, your money is pitted against inflation which can reduce your dollar buying power. Discounted cash flows take these factors into account when arriving at the valuation of the business.
However, when using DCF, one should take care of projections that are done. A reasonable growth rate can help in arriving at a reasonable valuation but an overly optimistic growth rate can make valuations unacceptable by investors.
4. Comparable Transactions
In this method, valuation is done by looking out for similar business which was sold in recent past. This comparison is possible only if the businesses have the same set-up, similar number of products, employees, market share and liabilities like loans.
Which method should you use?
That would depend on factors such as the industry and sector it operates in, what the business is expected to achieve in future, the presence of competitors, and the technology you use in your business. The best approach to follow is to use several methods to estimate the value of business and then use the mix that reflects the final value estimate.