Business Valuation

Business owners who are ready to sell their business will often wonder, what is my business worth?

This is likely the first question they’ll ask themselves since it is the most important; the value of the business determines how much they can obtain if they sell the business.  But, before you plug a couple of numbers into a business valuation calculator or base a business valuation on a rule of thumb such as a business’s revenue, let’s consider a few things.  Business valuations are complex.  No two businesses are the same.  A mistake can cost you hundreds of thousands, if not millions of dollars.  Is that worth it?

Rules of Thumb

If you’d like a few simple rules of thumb, do NOT start with a percentage or multiple of revenue.  Revenue, while necessary, does not ultimately pay the bills.  Other rules of thumb might be industry-specific, such as a multiple of renewal revenue in an insurance agency.  This is a dangerous way to value a business.  These rules of thumb might tell you what cash flow ‘should’ be, but what if the seller is selling products or services at cost or slightly above cost?  This increases revenue, but not cash flow.  Want to do it right?  Start with what the business earns in a given year.  Most business brokers would define this as Seller’s Discretionary Earnings or SDE, for short.  You can think of SDE as EBITDA (Earnings Before Interest, Taxes, Depreciation, & Amortization) + Owner’s Salary (salary, NOT distributions) + one-time adjustments.  Most small businesses trade for 1 – 4 times their annual Seller’s Discretionary Earnings (SDE).  Why 1 versus 4?  What adjustments are included in SDE?  Is SDE the same as net profit (answer = no)?  These are the million dollar questions.  Most online guides are wrong.  You must know what adjustments are acceptable to buyers and the banks.  This is also where most business brokers go off the tracks.  Here at CGK, we know what is acceptable and what is not.

Most medium-sized businesses trade off of a multiple of adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).  Depending on the size of the business, the trends, and the industry, this is normally 2 – 5 times for lower-middle market businesses and 3 – 8 times for solid, middle-market companies.  When do we use adjusted EBITDA versus SDE?  What’s the difference between the two?  What adjustments are acceptable for these businesses?  What about multiple expansion or contraction during the business cycle?  You may say, “These numbers are backwards-looking, what about my future numbers?”  “What’s this ‘intrinsic value’ that Warren Buffet talks about?”   Do you see the problem with ‘rules of thumb’?  For a relatively inexpensive business valuation, especially compared to the money at risk, CGK Business Sales can guide you down the right path, so you can make an informed decision.  Can you really afford to make a mistake?

Multiple Approaches to Business Valuations

There are a number of different business valuation methods that are in use today, but three that any business owner will want to know about are the asset approach, the income approach, and the comparable transactions approach.