Valuing a Small Business Overview

Valuing a small business for sale is the process of determining the worth of a company to know what to ask for it when putting it up for sale. Only 30% of businesses put up for sale actually sell,  so it is important to price it correctly to increase your chances of selling it and getting a good price for it. Price it too high, and you risk not selling it; price it too low, and you risk selling it below market value. The trick then is to find the middle ground, and there are a number of techniques for doing so.

How to Value a Small Business

The first step in valuing a small business involves arriving at an estimate. To do so, the following approaches should be taken:

The Market Approach. In this approach, the value of a business is determined by comparing the business to other businesses in the industry that are of similar size and ideally, in the same region. You may also consider asking other business owners for estimates of their business’s worth. Either way, the market approach is the most subjective, as the factors it values are subject to more intangible influencers, like market conditions and customer goodwill.

The Multiplier Approach. This approach uses the law of supply and demand to determine value. Businesses that are in demand include those with low risk, a well-established franchise presence, long leases in densely populated areas, and little direct competition. Businesses with many positives will receive a higher multiplier than those with few positives, with this multiplier being applied to the business’s cash flow to determine value. Additionally, businesses that are more common, like restaurants, will receive a lower multiplier due their abundance.

The Asset Approach. This approach is the most straightforward, as it determines value by simply taking the worth of a business’s assets and adding them together. A good accountant will also take into account depreciation when calculating a business’s value while using this method. This is a very conservative valuation method, usually most suitable when a business is not regarded as being an on-going concern.

The Adjusted Net Income Approach. This method determines value by calculating the revenue stream of a business and projecting its future profitability. This is a more technical method involving discounting future cash flow, applying multipliers to EBIDA (Earnings Before Interest, Depreciation, Amortization), and applying stock analyst techniques used to value public companies. If you are running your business as an owner-operator, a formula known as the seller’s discretionary cash flow (SDCF) can be useful in evaluating cash flow. If your business is larger, other methods may be more useful.

Once you have used one or more of these methods to come to an estimated value, it is recommended that you review your calculations to make sure they are correct. Some steps that can be helpful in this process include:

Double check your assets to make sure you have not overlooked anything. Even if an asset does not appear on your financial record, its value should be included.

Account for so-called “soft factors,” such as the age of the business or property, the location of the business, and the business’s reputation. Such factors can drastically effect a business’s cash flow value.

Remember to factor in the terms of sale: for example, on average, asking for all cash for a business will yield 60% to 80% of the value that would have come from asking for a down payment and then taking the rest in installments with interest. For this reason, the structure of a business deal is a crucial component to the process of valuation. Structures that may appeal to buyers include those that delay payments until a few months after the sale or those that have low interest rates. 

It may also be helpful to hire a business attorney to assist you in determining the value of your business. A professional with experience in such matters will know what questions to consider and the proper formulas to use that will yield the correct value.

If you need help valuing a small business for sale, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.