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There are many reasons to understand what your business is worth. Contact us and ask for our valuation team. Below is an informative article on business valuation by Andrew Cagnetta, one of our experienced valuation experts.
How Much Is a Business Worth?
Valuation is the top question sellers ask when considering a sale and also a key concern for buyers before purchasing. Unfortunately, there’s no simple answer—often, there are multiple answers. Why? Because business valuation is more of an art than a science. It depends on the appraiser’s judgment, skill, and chosen methodology. There are different standards of value for businesses, such as:
- Fair Market Value – The price at which a willing buyer and willing seller would transact without pressure, both fully informed.
- Intrinsic Value – The value investors would place on stock.
- Fair Value – Legal standards often applied in contexts like divorce.
- Investment or Strategic Value – The value specific to certain buyers, which may exceed fair market value.
Fair Market Value Explained
For our discussion, fair market value refers to what a buyer would pay for your company in an open market. Keep in mind this is a simplification of complex valuation practices. Some specialists provide detailed valuation reports used for IRS inquiries, legal cases, or complicated financing, which can cost between $10,000 and $30,000. For small business sales, a full valuation is usually unnecessary; our streamlined methods typically suffice to set your listing price and estimate your sale value.
Common Valuation Approaches
There are three widely accepted approaches to business valuation:
- Asset Approach This method calculates your business’s assets minus liabilities, using techniques like book value or asset accumulation. However, this approach often doesn’t reflect the true value of an ongoing profitable business.
- Market Approach Similar to real estate comps, it compares businesses of similar size and industry. We use public company benchmarks or private sale databases to find valuation multiples based on sales and earnings. This method is generally reliable and a strong indicator of value.
- Income Approach This considers the present value of future income streams your business can generate. Methods include discounted future earnings and capitalization techniques. This approach relies on projected growth and earnings, but many buyers prefer using historical earnings as a reasonable estimate of future income.
Understanding Multiples of Earnings
What does this all mean? Simply put, your business’s value is often a multiple of past earnings, assuming the buyer believes those earnings will continue after purchase.
What Earnings Do We Multiply?
Common metrics include net income, EBITDA, or owner’s benefit. For small businesses (under $1 million in earnings), owner’s benefit is used, which includes net income plus depreciation, interest, owner’s salary, and benefits—essentially all income available to a single owner if the business were debt-free. Larger businesses use EBITDA, which normalizes executive salary and benefits.
What Are Typical Multiples?
Multiples for owner’s benefit typically range from under 1 to about 3. For larger companies with EBITDA near or above $1 million, multiples can range from 4 to 6. These numbers aren’t fixed and depend on factors like business size, quality of financial records, growth prospects, and profitability. Poor financials and negative outlooks yield lower multiples, while strong books and bright futures earn higher multiples.
Important Note: The Buyer Decides Value
Ultimately, the buyer determines the sale price—not valuation experts, bankers, CPAs, lawyers, or advisors. Each buyer values a business differently, so exact worth is subjective.
Summary: What Is Your Business Worth?
- A multiple of earnings compared to similar businesses (gross sales or owner’s benefit times an industry multiple).
- Capitalization of net profit (not owner’s benefit) typically between 20% and 50%, or a simple multiple of owner benefit.
- For businesses with little or no profit, asset value (goodwill, inventory, equipment, etc.) is the only value, either sold as a whole or liquidated over time.
How to Narrow Down Your Business Value?
Call a valuation specialist. Call H3K!
Many factors affect your business’s value, including location, size, competition, growth trends, quality of records, ease of transfer, timing, sale terms, leverage, and your business advisor.
Remember, this is a simplified overview of a complex subject. For a formal valuation, consult H3K, a valuation professional, or an expert familiar with business sales. Now that you understand how businesses are valued, you can focus on increasing your profits and maximizing your sale price.