Three Business Valuation Methods You Need to Know About
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. 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.
Asset Approach to Valuation
This business valuation approach is done by determining the values of the assets and liabilities for the business. The liabilities are subtracted from the assets, and the difference is going to be the value of the business. This can be a great way to determine the value of the business if the business may not continue and needs to be liquidated, as it’s relatively simple to determine the value of all assets and liabilities. However, this doesn’t take into account things that are valuable to the business but that don’t have a price that is easily determined, such as intangible assets. In general, the asset approach is usually not used for businesses that will remain as a going-concern, though it can be a baseline figure.
Income Approach
This method takes into account what the business will make in the future and discounts this amount back to a present value. Examples of this approach include discounted cash flow and capitalization of earnings methods. For instance, in the discounted cash flow (dcf) methodology, the future amount the business should likely earn is determined. Then, a discount rate is applied to determine the terminal value and present sum of the business’s future cash flows. This determines the current value of the business. Sound confusing? It is. A properly trained M&A advisor can walk a seller through this important way of valuing a business. This lets potential buyers see how well the business could do in the future, plus allows for businesses with uneven cash flows to be properly valued. The income approach is the theoretically correct way of valuing the business, so it cannot be ignored. Though, predicting future cash flows is, of course, hard, especially when it comes to the cyclical nature of most businesses and economic cycles.
Comparable Transactions Approach
This is a common way to determine the value of a business. The business model is compared with similar ones that have been sold recently to determine the value of the business. This method takes into account the current market for buying and selling businesses, and is a common methodology for business valuations. This method can suffer from peaks and valleys in different economic cycles. It can still be an effective way to market a business and is one that has often been used very often in the past to determine the value of a business before it is sold. As part of the comparable transactions approach, many buyers and sellers may speak of market multiples, often valuing the business as a multiple of adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) for larger businesses or SDE (seller’s discretionary earnings) for smaller, main street transactions. There are often adjustments made for buying the entire business, called control premiums, or discounts, for lack of marketability or size. Which multiple is used and the adjustments made, either via add-backs or discounts/premiums, can make or break the value for a seller.
Choose the Right Valuation Approach
Business owners will want to make sure they take the time to learn more about the various approaches that can be used and work with a professional to ensure they find the right one to help them determine the valuation for their business to help them with a sale. A mergers and acquisitions advisor is going to be able to work with the business owner to determine which or all of these approaches is going to be the right ones to use for their business to prepare for a sale.
So which valuation methods are the right ones for your business and what are the differences between them? Speak with a mergers and acquisitions advisor today to learn more about selling your business and about how to choose the right business valuation. This is an important step you’ll want to do carefully when you’re ready to sell your business. Call or confidentially email CGK Business Sales below to determine the value of your business.