Are you looking to buy or sell a small business in the United States? Here is a guide that will help you make the right decision when valuing a business. Whether it is made available for purchase or sale in your state. Here you will know how to value a small business if you are looking to buy or sell one.
Purchasing or selling a business requires a couple of important tasks as well as certain legal requirements with paperwork from the county, state or federal government. Learning how to value a business is the process of calculating what a business is worth and could potentially sell for.
The calculation factors in seller’s discretionary earnings (SDE) times an industry multiplier, tangible and intangible assets, and current liabilities. An accurate business valuation can be used to negotiate a price when you sell your business.
Make sure you maximize your payout when selling your business, it is important that you collaborate with an experienced business valuation provider. The specialist will supply you with a detailed valuation report, complete with a financing assessment and an in-depth industry analysis. Take advantage of this vital information to sell your business for, or buy a business with the right price.
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In general, a business valuation represents the company’s total worth. The business’ value can be calculated with the help of a specified formula, which also includes taking into account the company’s assets, earnings, industry, and debt or losses if there is any. Completing a business valuation on your own can be pretty much complicated and it may as well not even represent the exact price you will actually sell your business for.
You can calculate the value of your business manually as well. This can be achieved by following three essential steps, which are thus, given below. This valuation will still be an estimate, but it will be a bit closer than a basic calculator can provide. Regardless, it is important to benchmark your initial sale price with a reasonable value for your business.
The following are the three steps that will help you determine the value of a business:
A lot of specialists will agree that the starting point for valuing a small business is to normalize or recast the business’ earnings to get a number that is called the “Seller’s Discretionary Earnings (SDE)”. SDE is the pre-tax earnings of your business before non-cash expenses, owner’s compensation, interest expense, and income, or one-time expenses that are not expected to continue in the future.
Small businesses report expenses on their tax returns with an eye towards reducing their tax burden. This means you likely claim many deductions that lower your business income on your tax return. For this reason, using income numbers from a business’s tax return can underestimate how much revenue the business actually produces.
SDE gives you a better idea of the business’s true profit potential by calculating what the business’ earnings would be with a new buyer. This is done by adding back in expenses listed on your tax return that are not necessary to run your business. This includes your salary as the business owner and any one-time expenses that are not expected to recur in the future.
Here are some examples of things that would be added back into the net income reported on your business’ tax return to calculate SDE:
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Businesses typically sell for somewhere between 1 and 4 times their SDE. This is “SDE multiple” or simply “multiplier”. Finding the right SDE multiple is really more important because it varies based on the following:
Think of the industry-standard multiplier and the specific business multiplier as two separate numbers, one giving you a general value based on industry averages and another giving you a specific value based on variable factors of each individual business.
The biggest factors influencing the SDE multiple are usually owner risk and industry outlook. If the business is highly dependent on you or another owner, it cannot be easily transferred to new ownership and the business’s valuation will suffer.
If you are selling a business in an industry and/or area that is expected to grow in the near future, the SDE multiple will be higher. For a more personalized estimate of the multiple, you can also consult a business broker or appraiser.
The final step of how to value a business is to account for business assets and liabilities that are not in the SDE. Most small business sales use the legal structure of an “asset sale”, which means the purchaser is buying the tangible and intangible things that make the business what it is. Typically the seller keeps liabilities, but deal terms will vary from sale to sale.
Tangible assets owned by the business that you can put a value on. Some examples include real estate (if the business owns any property), accounts/receivables, and cash on hand. These are generally not included in the SDE multiple. All tangible assets should be added to the valuation separately if you are purchasing them.
Intangible assets have a value for a specific business purpose, like reputation, trademarks, patents, and goodwill. These assets are included in the SDE multiple because they are typically only sold if your business’ assets are sold.
A business’s current liabilities are debt or other obligations the business has that it must pay for in the future. Many sales have been lost by sellers unwilling to keep the liabilities they created for the business. Liabilities that will factor into your calculations include notes payable, accounts payable, business loans, accrued expenses, and other debts or payables, as well as unearned revenue.
An asset sale typically structures where the seller pays off the business liabilities with proceeds from the sale. However, it gets more complicated when discussing things like an open line of credit facility that the business needs in order to continue operations.
One way to determine what the potential liabilities are for a business is to run a business information report through Dun & Bradstreet. This can be purchased on virtually any company, by anyone, for $121.99 and will give you information such as:
It is a cheap way to get information about the business. And to confirm that you are not missing any important liabilities. It is important to note that this may not include all liabilities, but it should give you a good estimate.
Use the formula below to come to estimated business value:
Business’ Estimated Value =
(SDE) * (Industry Multiple) + (Real Estate) + (Accounts Receivable) + (Cash on Hand) + (Other Assets Not in SDE or Multiplier) – (Business Liabilities)
These valuation grounds are also necessary as they can help a person determine the acceptance or rejection of a particular small business. Let us take a look at these important methods that necessary in the valuation of a small business.
This method of small business valuation calculates the net value of a business’s assets, which can be both tangible or intangible, minus the value of its liabilities. This type of valuation method commonly uses by businesses that hold investments or real estate that are not generating a profit or are seeking to liquidate.
This method of small business valuation calculates the company’s value which is based on the purchases and sales of comparable companies and which lie within the same industry. This type of valuation method can be used by any business, as long as you can find sufficient data on comparable companies.
This method of small business valuation basically shows the annual return on investment (ROI), accounting for cash flow, future profitability and the expected value of a business. This method thus extends the calculations for a single period into the future. This type of valuation method commonly uses by established businesses having stable revenue.
This method of small business valuation basically shows the current value of a business’s future flow of cash, discounted according to the risk involved in purchasing the business. This type of valuation method uses by newer businesses having a high-growth potential, but which are not yet profitable.
Each business valuation method uses a different aspect or variable of a business in order to calculate its numerical value, either a business’ income, assets, or using market data on similar companies. Therefore, your ultimate business valuation should be the result of consistent calculations, so do not mix and match formulas. Investigate numbers that do not seem right and don’t be afraid to seek extra help from an accountant.
Now that you understand how to value a business on your own, you will want to maximize that value before you sell. There are both short and long term tips that can help you improve your business valuation and help you the largest sum possible for your business.leg
It is important to properly prepare for your business valuation like you are getting ready to sell your business. You can do this in many ways such as getting a third-party CPA to help you get your books to pay off your debt. The important thing is that your business is ready to maximize its sale value.
One major problem with using an SDE multiple to value a business is that the number is backward-looking. When valuing a business, it is important to look at the future, even if you are the seller. You will want to present a case to potential buyers that your business’ revenues and profits will grow and the business should have a higher multiple as a result.
A buyer also wants to consider factors that might be challenges or opportunities for the business going forward. The best way to do this is to provide projections based on how the business could perform in the future in best-case and worst. It could help the buyer understand what your expectations are for the business and give them a level of comfort that it will continue to perform at or better than current performance levels.
It is important to control the public’s perception of your company before you try to sell it. Perception often is a reality in business, and business with loyal customers will almost always sell for more. Improving your market share and promotional strategies come before selling to increase your business’ sale price.
Many experts agree that sellers set the asking price for their business too high. This is because sellers often think that they are the only ones who can properly run their businesses. They place too much value on the amount of time and effort that they have put into the business. Even if the financials do not support such a high valuation. Having a number like SDE to support the valuation helps take all emotion out of the valuation process and results in a more accurate estimate of the business’ worth. Plus a valuation from a professional adds credibility to your asking price.
Before setting out to value a business you must to decide how you are going to conduct the valuation. You can either value the business on your own or you can hire a professional appraiser or business broker.
Make sure that you have key employees committed going forward, in case the buyer needs them to stay. Also, work on getting all of your key contracts lock up for as long as possible. If you have important contracts coming up for renegotiation in the next year, then try to get them extended.
While most business owners spend tax season finding every business expense they can possibly claim in order to reduce their tax bill, that may not be the right move before you value your company and try to sell it. Paying more taxes will also make it easy to show any potential buyers what the company is making right from your tax return, which is a value that is hard to argue against. Many potential buyers analyze more than one business at a time to find the right match for them. The easier you make it for them to see the value of your business the more likely they take a closer look at yours.
If you are serious about looking for a buyer, be mindful of the impact that selling your business will have on your employees. In the exploratory stages, it is a good idea to keep things confidential. Even if you are committed to ensuring that your employees are taken care of.
So, even before you begin valuing your business, decide how much information to share with your employees. Depending on your team and your management approach, you might choose to include everyone in the process and if you do not personally handle your business’ finances and tax filings, there is a good chance your employees will be involved, anyway.
In this case, you might want to consider a non-disclosure agreement. However, keep in mind that both your business’ partnerships and your customers will be affected when your business is sold. Although a sale may be far in the future, these relationships will start to change as soon as you announce plans to sell your company.
Whether or not you are valuing your business to prepare for a sale, having an accurate number in hand can only be positive. Once you are confident in your valuation, you can mobilize your knowledge about your assets and earnings to make decisive improvements or necessary changes.
Learning how to determine a business’ value is a great way to better understand your own business’ finances and assets. Plus, knowing the value of your business can help you navigate any unexpected market turns or inbound offers.
Several business valuation experts agree that business valuation is more of an art than a science. While using the SDE method of valuation should give you a good estimate of your business’ worth. It is a advise to use professional assistance for more accurate calculation.