Small Business Valuation: A Guide for Business Owners
By Mor Schlesinger / CTO
As a business owner, you may need to estimate the value of your business for a variety of reasons. Whether you're preparing for a sale, seeking financing, or just want to understand the financial health of your business, understanding the valuation process is crucial. In this article, we'll explore how to estimate the value of your business, explain the different terms that come up in this process, and discuss what you can do to best prepare for the valuation process.
How to Estimate the Value of Your Business
There are several methods that can be used to estimate the value of a small business. The most common methods are the market approach, the income approach, and the asset approach.
The market approach looks at the prices of similar businesses that have been sold recently. This method assumes that the market will pay a fair price for a business based on what other businesses have sold for in the past. This can fluctuate based on demand, similar to what we saw in 2020 with the rise in demand for Amazon businesses which resulted in a skyrocketing of business valuations for those types of businesses compared to previous years. This is the most common type of valuation for small businesses.
The income approach looks at the future cash flows of the business. This method calculates the present value of the future cash flows that the business is expected to generate. This method is often used for businesses that have a proven track record of generating consistent income.
The asset approach looks at the value of the business's assets. This method calculates the total value of the assets that the business owns, minus the liabilities that it owes. This method is often used for businesses that have a significant amount of tangible assets.
Terms to know:
When calculating the value of a business, several terms are used that may be unfamiliar to many business owners. The most common terms used in the calculation of the value of a business are:
Seller Discretionary Earning (SDE) - This can be calculated by taking your pre-tax net income and “adding back” any expenses that a potential buyer wouldn’t adopt such as your own salary or discretionary expenses such as consulting fees, travel expenses, etc. These are called “add backs”. This is the base value that will be used when calculating your business’ value.
Up front / Earnout - Buyer’s will often split their offer into an upfront cash payment and an earnout. The upfront cash payment will be transferred immediately after the transaction is complete, while an earnout is often a potential future cash payment that is dependent on milestones, for example, a 10% increase in SDE by 1 year after the sale.
Multiple - This is the number used to multiply the business's SDE or other earnings measure to arrive at a value for the business. The multiple is often determined by looking at the multiples of similar businesses that have been sold recently.
What you can do to prepare:
There are several things that a business owner can do while running his business to make the valuation process easier. These include:
Keep accurate financial records - Having accurate financial records is essential for any business, but it's especially important when it comes to valuation. Make sure that your financial statements are up-to-date and that they accurately reflect the financial health of your business.
Maintain good relationships with customers and suppliers - A strong customer base and good relationships with suppliers can increase the value of your business. Make sure that you're providing excellent customer service and that you're paying your suppliers on time.
Plan to get a valuation when your business is on a growth trajectory - Businesses that are seen to be growing often receive a higher valuation multiple.
Estimating the value of a small business can be a complex process. However, by understanding the different methods used to calculate value, the terms used in the calculation, and what you can do to make the process easier, you can ensure that you're prepared for more opportunities in the future.
If you’re an eCommerce seller, you can quickly and easily connect to boosst’s software to track your business’ value on your own personal dashboard. You will also have access to a personalized profit and loss statement .
Why did we build boosst?
It can be a very difficult process to buy or sell a business, both financially and emotionally. We built boosst so you would never feel alone in the process. We believe that we can empower founders and give them insightful data in order to create their future according to their terms.
Looking to sell your business? Check out how boosst can help.
Looking to buy a business? Check out how boosst can help.
Book a free call with our M&A team lead here > Click here.
About the Author
Mor Schlesinger, Co-founder and CTO of boosst. Mor was a former combat soldier in the Israeli army and the lead developer at V-Labs, a SAAS startup that exited last year. He is now leading our development team at boosst.
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