Small Business Valuation: How to

Determine Your Business's Worth

When you run a small business, you're responsible for handling multiple
responsibilities. From bookkeeping to marketing to developing your product or
service offerings, small business owners are busy. While it's not always easy to find
time to complete additional tasks, small business owners should take the time to
determine their business's value on a semiregular basis.

With small businesses being sold at historic rates, it's important that your
business be ready for a potential sale. Even if you don't want to sell your business,
it's a good idea to know what your business is worth.

Determining your business's worth can be easier said than done, however. If you're
unsure of how to find your business's worth, it's important to speak with a business
expert to get an accurate valuation. We spoke with experts who shared a few tips for
how businesses can best go about finding their value.

What's the benefit of knowing your business's value?

The business's value is incredibly important information for any business owner
considering selling their business. Going into a negotiation without a prior
understanding of what your business is worth puts you in a position to lose money.

Many small business owners neglect to calculate their business's value. This
omission can be easily remedied. If you're putting countless hours into a business,
speak to a business appraiser or business advisor – they can help you determine
what your business is worth.

"Many business owners expect the income they make from the future sale of their
business to fund their retirement," said Justin Goodbread, owner and CEO
of Financially Simple. "Yet, most do not have a formal valuation done on their
company until they are ready to sell it. Many are then shocked to learn that they
haven't created enough value within their business to reach their retirement goals. If
you wait to assess your business's value until you want to retire or have to retire, you
have no time to increase the value of your company. You will only get what you can
get, whereas if you know your business's value ahead of time, you can work with
professional advisors to increase the value of your capital – your cash flow, your
tangible assets, and your intangible assets – which will then increase the value of
your business."

What factors should I be aware of when placing a value on my business?

In addition to using specific formulas to calculate business value, it's important to be

well versed in a few key business areas.

 Tangible assets – Tangible assets include things like machinery, property and inventory.
It's easy to calculate the value of tangible assets.
 Intangible assets – Intangible assets include things like brand recognition, trademarks and
patents. These assets can add tremendous value to a business, and you should have some
idea of the monetary value of your intangible assets.
 Liabilities – Any debts your business owes factor into its valuation.
 Financial metrics – Is your business profitable? If so, what's your annual profit? How much
revenue does your business bring in? Know your financial statements inside and out, as
potential investors or buyers will want to know about your financials.

Knowing what your business possesses is an added benefit of going through a

business valuation. By looking at both tangible and intangible assets, you learn what
makes your business valuable and just how valuable those assets are.

Even if you don't sell your business, knowing your business's worth can provide
additional insights into future business decisions. Is your brand recognition not worth
much? You may put more time into future marketing campaigns to better build your
business's brand. Do you have a lot of money tied up in inventory? This insight may
change the way you handle inventory procedures moving forward.

How to calculate your business's value

Your business's value depends on a variety of factors. The size of your business,
your team, your expected growth and a plethora of other factors affect how valuable
your business is. When it comes to calculating your business's value, there are a few
formulas used regularly. The formula used varies by business, and calculating a
business's value is far from an exact science.

"Unfortunately, if we have 10 different people in a room trying to determine a price

for our business, we will more than likely receive 11 different answers," said David
Creech, owner of DVAR Business Group.

Before diving into the formulas, it's important to define seller's discretionary earnings
(SDE) and earnings before interest, depreciation, and amortization (EBITDA). SDE
refers to a business's net income prior to deducting the owner's salary. Other
discretionary, non-operating expenses are added back in for the calculation.
Calculating EBITDA is clear-cut, as the name describes what goes into the
calculation. Generally, SDE is to calculate the value of small businesses, while
EBITDA is used for larger businesses. Some sources use gross annual sales of $1
million as the benchmark for the difference between a small business and larger
business, but there's no set rule on when you should use SDE or EBITDA.

"I like to use the SDE model when I price small businesses," said Creech. "I inspect
the profit/loss statements, determine owner benefits and addbacks, then add to the
net income. I then use this sum and multiply by the industry's specific multiple. This
gives me a ballpark figure to begin negotiations with potential buyers."

Industry-specific multiples apply to both the SDE method of calculating a business's

value and the EBITDA method. These multiples vary by industry and are based on
industry trends and history. To find an accurate multiple for your industry, you can
search online and use the advice of a site like Valuation Academy, or you can
speak with a qualified business appraiser, which may lead to a more thorough
examination of what multiple makes sense for your business.
According to Jeff Rasmussen, principal consultant at Fairway Business
Advisors, the multiple of EBITDA method is one of three standard formulas for
calculating business value: "There are three primary methods of calculating the value
of a business: multiple of sales, multiple of adjusted EBITDA, and discounted cash
flow of adjusted EBITDA."

Multiples are decided by a variety of factors, including the industry, business size
and business growth. A business's multiple changes over time. To calculate an
enterprise multiple, or EV multiple, you perform the following calculation:

EV/EBITDA = enterprise multiple

EV is calculated by adding market capitalization, debt, minority interest and preferred

shares. You then subtract cash. The subsequent enterprise multiple provides
information to potential investors or buyers, as low ratios may mean a business is
undervalued. This calculation is largely used for big businesses and shouldn't draw
much attention from smaller organizations.

In addition to these three methods, using a comparative method to other businesses

in your industry is another way to get an accurate idea of what your business is
worth.

"For small businesses, I would recommend using the comps method," said Brian
Cairns, founder of ProStrategix Consulting. "Try to find a business similar to
yours that has been sold or received funding. Apply that multiple to your sales.
Sometimes, business brokers can be helpful in this, and sometimes average
multiples are published. If you can't find comps, I would suggest you consult a
professional."

Be careful about relying too much on formulas, though, as they don't always tell the
full story.

"A flaw in the use of formulas can be demonstrated as follows," said Seth Webber,
principal and the head of BerryDunn's Valuation Services Group. "Company A had
an average EBITDA of $1 million for the last five years. Company A owns a taxi
company in a city that has aggressively pushed back against the use of Uber.
However, the political climate has shifted, and Uber is about to enter their city.
Company B also has average EBITDA of $1 million for the last five years. Company
B is a pharmaceutical development company. They just got their most recent drug
approved by the FDA and expect to quadruple their EBITDA going forward. Both
companies have the same amount of EBITDA. Are they worth the same amount?
Certainly not."

How do investors valuate my business?

When determining your business's value and what factors play into business worth,
figure out what a potential buyer or investor wants to know.

"There are straight mathematical ways to determine the value of a business, but
those are dependent on the quality of the data used in the calculation," said Michael
Ott, CEO of Rantizo. "Oftentimes, it ends up with an agreement between a lead
investor and the business based on a number of factors that are acceptable to both
sides."

In short, if you're looking to attract investors or buyers, you need to appeal to the way
they valuate businesses. If they use the SDE and multiple methods, use that to
determine your business's worth. If they use another method, that may be the
method used to agree on a purchase price and valuation.

"I have owned and sold my own businesses along with assisting others [to] do the
same," said Creech. "I have found one truth that is always consistent – all that
matters is what you are willing to sell for and what I am I willing to pay."

If you're calculating your business's value just for informational purposes, try using a
few different methods to get an idea of how different investors and buyers may value
your organization.

"Valuations are more of an art than a science, especially for early-stage private
companies," said Ott. "If there are revenues, and they are representative, a proper
multiple for the industry can be used to get a fairly accurate number. If there aren't
revenues or they don't reflect the direction of the business, more interpretation is
needed. There are a dozen ways to value a business, and a successful strategy can
be to try three or four and use a hybrid."

How can I value my business at different stages in its growth?

It's easier to estimate the value of a business that's been around for 30 years than it
is to value a startup. The startup has fewer years of financial statements, and it's
hard to know how large the brand may become. A 30-year-old business, on the other
hand, has years of financials and an established brand that can be easier to value.
This makes calculating the value of your business at different stages of its growth
cycle difficult.
With challenges like this, you can utilize a few different methods and project
numbers to get a few general estimates of your business's worth. The best solution
is to speak with an investment banker or someone experienced at calculating
business worth, suggests Stephen Opler, partner at Barnes & Thornburg. He
explained that business owners may struggle in negotiations with potential buyers if
they aren't periodically aware of their business's value. If someone offers to buy your
business out of the blue, it's good to know if that offer is consistent with market
value.

"As I say to people, there's nothing more boring than a one-horse race," Opler said.

Speaking with a professional business appraiser makes it easier to check your

business's worth during different growth stages, which prepares you for a potential
sale of your business. While speaking with an expert can be costly for larger
businesses, the benefit may be worth the price of an expert's strategic insights.

"If you spend $1 million on an investment banker, it seems like a lot of money, right?"
Opler said. "But if they increase the purchase price by $1.5 million, do you really
care?"

How often should I calculate my business's value?

Calculating business value for informational purposes can be done in a few ways.
You can use a few formulas and create estimates for your value, or you can speak to
a business appraiser. For informational purposes, and assuming you aren't
expecting to sell your business in the immediate future, it's not necessary to bring in
a business appraiser. Bringing in a business appraiser would make for a more
accurate valuation, but the added detail might not be worth the cost.

"Until you are ready to sell or do a buyback from your partners, knowing the value of
your business is simply a feel-good exercise, but one that can serve as a reference
point moving forward," said James Cassel, chairman and co-founder of the Miami-
based investment banking firm Cassel Salpeter & Co.

If you don't have plans to sell soon, and you just want an idea of what your business
is worth, an annual valuation is a suitable timeframe. Others may suggest an annual
valuation done by your own calculations and speaking with an appraiser every
couple of years. It depends largely on your business needs and when you expect to
be in the market to sell your business.

The bottom line

It's a good idea to know your business's worth, and there a few different ways to
come up with valuations. Regardless of the method you use, consider updating your
calculation annually, and speak to a professional business appraiser for the most
accurate valuation possible