Determining Your Business’s Market Value
You’re ready to sell your business and use the proceeds to help finance your retirement or your next venture. There are a number of ways to determine the market value of your business.
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Tally the value of assets. Add up the value of everything the business owns, including all equipment and inventory. Subtract any debts or liabilities. The value of the business’s balance sheet is at least a starting point for determining the business’s worth. But the business is probably worth a lot more than its net assets. How much revenue and earnings can you expect? -
Base it on revenue. How much does the business generate in annual sales? Calculate that and determine, through a stockbroker or a business broker, how much a typical business in your industry might be worth for a certain level of sales.For example, it might typically be about two times sales.
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Use earnings multiples. A more relevant measure is probably a multiple of the company’s earnings, or the price-to-earnings (P/E) ratio. Estimate the earnings of the company for the next few years. If a typical P/E ratio is 15 and the projected earnings are $200,000 a year, the business would be worth $3 million. -
Do a discounted cash-flow analysis. The discounted cash-flow analysis is a complex formula that looks at the business’s annual cash flow and projects it into the future and then discounts the value of the future cash flow to today, using a “net present value” calculation. It is easy to find and use an online NPV calculator. -
Go beyond financial formulas. Don’t just base your assessment of the business’s value on number crunching. Consider the value of your business based on its geographical location. In addition, consider its potential strategic value to a would-be acquirer if there are business synergies.
- Use a net present value calculator.
- Learn more about business valuation.
- Meet with and hire a business valuator. Find out more on the American Society of Appraisers website.
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How To Determine What Your Business Is Worth In Five Minutes Or Less
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As a business appraiser, I understand that most business owners looking to sell as a going concern are simply looking for a quick way to determine the fair market value of their businesses.
They are not interested in calculating the terminal value, weighted average cost of capital or discounted future cash flow of earnings. Small business owners don’t need or even want to make it that complicated; they just want to get a rough idea of how valuations work and how they can determine what their company is worth using “back of the napkin” math, not complicated and fancy Excel formulas.
So, skipping all the complicated finance theory that isn’t relevant to most main street business owners, let’s quickly determine how much your business is worth.
When it comes to business valuations, think AIM: asset method, income method or market method. We will focus on the market method primarily, but I’ll first mention how the other two methods work.
Asset Method: This method is simply calculated by taking the difference between business assets and liabilities. For example, if you have $100,000 in assets and $20,000 in liabilities, the value of your business is $80,000 ($100,000 – $20,000 = $80,000).
Typically, this is not the valuation method you want to use if you have a profitable going concern business.
Income Method: This method is a favorite for financial wizards and professors who love teaching theory. It’s not easy for most small business owners to understand, let alone calculate. In short, you have to determine the business’s future economic benefit (forecasting financials), adjusting for growth rates, cost structure, taxes, working capital, etc., and then discount that future economic benefit to a present value. It involves discount rates, discounted cash flow calculations or capitalization of earnings. Honestly, I feel tired and confused just explaining how it works.
Market Method: Let’s focus our time and effort on this method. It’s quick and easy to understand, and you’ll know within five minutes what your business is worth (or at least a general range). The basic premise is to look at what companies similar to yours in size, revenue and other characteristics have successfully sold for.
The value of your business is tied to that value.
Let me give you an easy example. Once you understand the math, you can apply this to your own business. According to BizBuySell data, average cash-flowing businesses sold for 2.28 times seller’s discretionary earnings (SDE).
First, let’s tackle what SDE is. If your profit and loss statement shows that you have a net profit of $100,000, you need to “add back” a couple of items. This includes any personal, discretionary and one-time expenses, as well as one owner’s salary.
Let’s assume you have a salary of $50,000 per year. Following the advice of your CPA to lower your taxable income, you use the business to pay for your family health insurance, auto, gas and auto insurance. You also have some depreciation and interest, as well as retirement contributions. Let’s assume all those expenses add up to another $50,000.
Here is what the math looks like:
• Net profit: $100,000
• Owner salary: $50,000
• Add-back expenses: $50,000 (these must be documented and justified)
• SDE: $200,000 ($100,000 + $50,000 + $50,000)
Now for the valuation:
• SDE: $200,000
• Market multiple: 2.
28
• Fair market valuation: $456,000 ($200,000 x 2.28)
There you have it. All you need to do to quickly determine the value of your business is to calculate SDE and multiply it by the average market multiple for your industry.
It’s key to determine what your market multiple is, and having access to successfully completed transactions is vital in this research. You’ll likely need to see a business broker who has the certified business intermediary (CBI) designation, or a mergers and acquisition specialist. Both of these professionals can look up the average market multiple for your industry and adjust it up or down based on the individual characteristics of your company and circumstance. A lot of training and professional standards go into determining this, so when the time is right to list and sell your business, don’t rely on 2.28 just because it’s the market average. Consider seeking out a professional to get detailed help.
Once you know how much your company is worth, you can then determine if it’s time to sell your business and cash out now, or continue building for an increased future valuation.
Here is the fun part: Using the example above, your business is worth $456,000, but you really want to sell it for $750,000. Just work the numbers backward, and you’ll know exactly what you have to show in annual SDE to justify a $750,000 valuation.
Here is what the math looks like:
• Goal sales price: $750,000 divided by 2.28 = $328,947
• Current SDE: $200,000
• Goal SDE: $328,947
Over the coming years, work at getting your company’s annual SDE to increase by $128,947, and you’ll justify your $750,000 valuation.
How to assess the value of a company — a ready-made algorithm
For many Belarusian owners, the issue of business valuation causes difficulties. Viktor Denisevich, a financial analyst at Zubr Capital, talks about the most practical valuation method and gives a formula for calculating the value of a company.
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– Company valuation is like playing chess. A chess player who plays white and one who plays black can evaluate the position on the board differently.
Likewise, the owner and investor are likely to have different views of the same company. nine0005
Obviously, this is because the owner and the investor have different goals. From the owner — to sell the company or part of it for the highest possible cost, from the investor — to buy a share or the entire company for the lowest possible amount.
When it comes to estimating the value of a company, there are an almost infinite number of ways to form it. But the most practical and adequate in this matter is comparative method .
Its essence is that you form an estimate, not only based on the internal resources of the company, but, first of all, based on information about the value of peer companies. nine0005
Let’s say we have a fictitious company «A», which is engaged in the production of shoes in Poland. Let’s look at her example, how the valuation of the company is formed.
If you want to know the value of your company, the first thing to do is start with a benchmark.
That is, choose companies-analogues and analyze their value. Of course, the availability of this information depends, first of all, on the development of the stock market and the openness of the M&A market in the region.
The first difficulty that you will encounter is the almost complete lack of information about peer companies, on the basis of which you can build an assessment in our country. How to solve this problem? nine0005
There are two verified sources of information:
- data from public companies around the world
- information about M&A transactions not only in Belarus, but also abroad
As a result, you will receive an array of data on different companies, regions, etc. d. Now the task is to choose the correct peer companies on the basis of which you will make your assessment. To do this, you need:
1. Define a wide sample of companies according to the general criteria that characterize your company (industry, region, revenue, product or service).
nine0005
Let’s look at our company «A». Using data on public businesses, we will compile a list of companies involved in the production of shoes in Europe. Here are 11 companies that, in their main characteristics, are similar to ours.
2. The next step is to narrow down this list using niche criteria. This includes market share, level of competition, management team, growth potential, financial performance, etc.
In our example, we will adjust the sample based on financial indicators. We are interested in companies with revenues from $30 million to $ 150 million So, we have 5 companies (highlighted in dark). Revenue figures are in $ million.
The next step is to choose a multiplier on the basis of which we will evaluate our company.
Historically, there are 3 types of multipliers:
- interval (determines the value of the company based on the results of its activities and is the most common, for example, EV/EBITDA)
- momentary (the value is determined based on the performance of the company at the reporting date, for example, from the statement of financial position) a sample of 5 peer companies was obtained, and each of them has its own multiplier value.
The next goal is to determine the value of the multiplier for your company based on the data obtained. For this you need:
1. Cut off extreme and/or non-representative values of the multipliers of peer companies .
After reviewing more detailed data, we found that the multiple for Fenghua SoleTech AG is not representative.
2. “Weight” interim results
After analyzing the remaining companies, we came to the conclusion that based on the region, strategy, market share, financial indicators, we should use the following weights to calculate the multiplier. nine0038
As a result, we got that the multiplier for our company «A» is 6.296.
3. Make final adjustments (for example, regional discounts).
We need to understand what fundamental relationships affect the formation of the multiplier.
This dependence is expressed by a formula that at first glance seems terribly complex.
EV/EBITDA = f(G,Ke,MARG,T) = f(G,BETA,DUM,MARG,T)
In essence, this formula answers the fundamental question: “What determines the value of your company ? nine0005
It depends on:
- your business margin, i.e. net profit margin (abbreviation «MARG»)
- the country in which your company operates (abbreviated «DUM»)
- the industry in which you work (in our formula it is «BETA»)
- from the tax rate that falls on your company («T» — in our formula)
- the company’s growth potential in the coming years (we use it as a variable «G») nine0028
- the company’s equity value (usually denoted by the symbol «Ke»)
country risks.
Each country causes certain risks for the investor.
According to the authoritative American researcher Aswat Damodaron, the table of country risks looks like this:
Similarly, industry risk is determined, which also affects the valuation of the company.
Let’s calculate the adjustments for our company «A». Initially, our multiplier was set at 6.296. Let’s look at the risks: we can exclude some of the risks and variables, for example, the country risk, because practically all companies from Poland got into the field of our comparison.
If we assume that the profitability of our company is slightly lower than the industry average in Poland, then we need to take into account the discount on profitability. In addition, Company A does not have audited financial statements in accordance with international standards. In this connection, it is necessary to make a discount to our calculated multiplier. nine0038
As a result, our company will be worth 5.91 EBITDA.
Thus, in the example of the conditional company «A», we see that the value depends on many variables and contexts that are important to consider.
You can see how different valuations can differ for the same company using the Deal simulator.
All in all, valuing a company is as exciting as playing chess.
How to value a business using three approaches? nine0001
How to value a business
using three approaches?Business valuation — calculation of the value of a company or a share in it, in which an expert analyzes the company’s performance in three approaches. In the article, we will analyze approaches to assessing a share in a business using the example of the tea bag manufacturer Chaika.
Why the company is valued
With a valuation report, it is not scary to sell the company cheap or invest in an unsuccessful project. Company rating needed for:
- buying or selling a business and an interest in it;
- mergers with other firms;
- decisions to issue or sell securities;
- preparing or updating a business plan;
- optimization or restructuring of an enterprise;
- comparison of the investment attractiveness of the project with other options for investing money.
Business valuation uses: income, comparative and cost approaches. Each of the approaches has assessment methods that differ in the way information is collected and analyzed. The choice of method depends on the goals of business valuation and the state of the company. nine0005
The company «Chaika» produces tea bags. One of the co-founders wanted to develop another project and decided to sell a stake in the business to partners. The partner’s share is 30%, you need to estimate its cost. In yellow cells, the forecast of income and expenses for the next 5 years, in green — data for 2019. The information was provided by the company’s managers, but the appraiser can calculate the forecast on his own.
Income approach
The income approach is based on the sum of expected returns plus their time value. For the calculation, the methods of discounting the estimated cash flows and direct capitalization are used.
nine0005 Discounting — evaluation of the receipt of money in the company at the discount rate. The method is based on the fact that the money and assets that the company has at the time of the assessment are worth more than the same money and assets in the future. Discounting is used in cases where the appraiser is not sure about the stability of the company’s profit, which means that profit over a period of time may differ from profit at the time of valuation.
Under the direct capitalization method, the valuation depends on the annual income of the organization, adjusted for the planned growth rate of the business. This method is suitable for stable growing companies. nine0005
Cash flows are determined based on the forecast of income and expenses, and the time value depends on the required rate of return of the object of assessment. To determine the required return, we studied the alternatives to buying out a stake in a project and the risks associated with it. For example, investors could put money in Sberbank at 6% per annum — the risk is low, the return is low.
Or launch two new projects: one with a 30% return at above average risk, the other with a 22% return and below average risk. So we came to the value of 25%. nine0005 Comparative approach
In the comparative approach, the company being valued is compared with similar organizations. The accuracy of the estimate depends on the reliability of data on competitors. To evaluate a business using a comparative approach, methods of transactions, capital market and industry coefficients are used.
Under the transaction method, the basis for calculation is the purchase price of a similar business in its entirety or the price of a block of shares. In the capital market method, the price of one share is calculated depending on the price of a share in a similar company. The method of industry coefficients is the ratio between the value of a business and its financial performance. To evaluate a business, you need to calculate the industry indicators of different enterprises.
For example, for oil and gas companies, the coefficients are based on the ratio of the value of the company and the volume of reserves, for telecom operators — on the ratio of price and user base. nine0048 It is difficult to find exactly the same organizations on the market, so we evaluated competitors according to suitable parameters: revenue, net profit, company value. Price to Sales — the ratio of the company’s value to revenue, Price to Earning — the ratio of the company’s value to net profit. Based on the given coefficients, we calculated the cost of «The Seagull». Then they took the average value — 26 million and calculated the share of the partner.
Cost approach
In the cost approach, the price of a business is equal to the price of the company’s assets. It is necessary to provide the expert with accurate information about the costs of acquiring and maintaining property and valuables. For calculations, the net asset method and the salvage value method are used.
nine0005 In the net asset method, the market value of each property is determined, and then debt obligations are deducted from the total assets. If the company decides to close, it is valued using the liquidation value method. Then the value of the business depends on the amount of the sale of each asset separately.
We evaluated tangible assets and inventories, and also took into account intangible assets — the company’s brand. The cost of the company’s debt was subtracted from the total assets and the resulting value was multiplied by the partner’s share in the business. nine0005
How to evaluate the value of your business
To obtain the final value of the object of assessment, you need to use the results of each approach and calculate the average value. The appraisal report will be useful if the appraiser has chosen suitable methods for calculations.
If the cost of one of the methods is very different from the other two, you need to figure it out and find the reason.
