How to Value a Business: How Much Is My Company Worth?
Jun 23, 2021
Learn how investors typically calculate the value of a business.
Most business owners assume that they can fund future lifestyle changes by selling their business. Yet very few owners go through the process of formal business valuation until they’re ready to sell. As a result, some are shocked to find out that the value of the business isn’t enough to meet their financial goals.
Benefits of Evaluating Your Business Regularly
When it comes to finding out how much your company is worth, it’s best not to wait. Owners who carry out formal valuations well in advance gain valuable insight at a critical time. Once you know your business’s value, you can create a robust plan to increase cash flow and assets in the long run.
If you evaluate your business once a year, you can develop a solid, data-driven retirement plan based on your company’s worth. By the time you are ready to sell, there will be no surprises in store. You won’t have to ask yourself, “How much is my company worth?” or “How do I value my business?”
Instead, you’ll be able to negotiate with investors and interested buyers from a place of certainty and knowledge. Having years of historical data from previous valuations supporting you will give you the upper hand.
How to Evaluate a Business
There is no single, correct method for finding out how much your company is worth. Even a simple business is far too complex for any single valuation method to arrive at a “true” number.
Investors, private equity professionals, and expert appraisers use multiple methods for calculating business value. Each method will arrive at a different figure, and many professionals prefer to use more than one valuation method before agreeing to a deal.
Some valuation methods focus on future projections and growth, making them better-suited for evaluating young companies and startups. Others focus on historical performance, making them ideal for well-established businesses. Choosing the right valuation method for your business often depends on the stage of growth it is in.
The different ways to value a business include:
1. Calculating Asset Value
If you add up the value of every asset the business owns, you will arrive at a starting point for calculating what your company is worth. This will include all equipment and inventory, minus debts and liabilities.
The problem with this method is that it assumes that your business is no more than the sum of its parts. It is essentially what a bidder might pay if all of your business assets were to be liquidated and sold. It doesn’t take into account how all of those parts might fit together to generate revenue. As a result, it’s incomplete – and probably much smaller than what you hope to sell your business for.
2. Evaluating by Revenue
Compared to tallying up the value of your assets, focusing on revenue can give you a better idea of how much your business is really worth. After all, your prospective buyer is probably going to run the business for profit – not disassemble it for parts.
To calculate your company’s value based on revenue, start with your annual sales. Then, compare that figure with sales figures from other businesses in your industry. If you know how much a similar business sold for, and you know its annual sales data, you can use your own sales data to solve for the implied value of your business.
3. Using Earnings Multiples
Earnings multiples give you a way to compare your business to its entire industry. This is typically done through its price-to-earnings (P/E) ratio. For example, if the average P/E ratio for an auto retailer is 20, and your auto retail shop has earnings of $200,000 per year, you could put a $4 million price tag on your business.
Every industry has a unique P/E ratio that is heavily influenced by the current valuation of public companies in that industry. This makes sense because it’s easy to calculate the value of a public business if you know how many shares of stock it has issued, the price of a single share, and if it has any debt. However, it can skew the results in investment-heavy industries like tech and healthcare, which can have P/E ratios over 100. Additionally, there may be differences between the public companies in your industry and your own business that could impact the valuation of your business.
4. Performing Discounted Cash Flow Analysis
Discounted cash flow analysis is a complex valuation formula that takes your company’s annual cash flow, projects it into the future, and then discounts the value of future cash flow to today. That final value is what is known as the net present value of your business.
This valuation method estimates the amount of money a buyer can expect to make with your company over time. It depends on accurate estimates on future cash flows, which means that unexpected future variables can skew its results. It also relies on discretionary factors like the discount rate, which reflects the fact that money in the future is worth less than money today and will be different for each investor. As a result, different input assumptions will result in different valuation outputs.
5. Incorporating Non-Numerical Data
Financial formulas are not the only thing that matter when evaluating how much your business is worth. There are some parts of your business that simply don’t have a well-established price tag. Geographical location, intellectual properties, and brand value are among the most common non-numerical elements included in business valuations.
These may turn out to be the most valuable assets you have. Factors like these can offer strategic value to potential buyers who can use them to create business synergies. A company in your industry may be willing to pay a premium to access your local market, use your patented technology, or leverage your company’s stellar reputation.
Different Buyers Will Evaluate Your Business in Different Ways
Every potential buyer has their own preferred method of appraising a business. Liquidators look at assets, while investors typically prefer earnings multiples or discounted cash flow analysis. Business owners and competitors in your industry may focus on non-numerical data entirely. There is no single correct way to find how much your business is worth.
The best thing for business owners to do is regularly calculate the value of their business using multiple different valuation methods. Performing one or more of these calculations once a year will help you prepare for eventual offers and give you the insight you need to know which ones are worth considering.