How to Value Your Business for a Sale

by Craig Anthony

2 min read

There are a handful of ways to estimate the value of a small business in preparation for a sale. Most commonly, these methods are based on property and assets that the company owns, or a mathematical method involving certain line items, such as net income or revenue. Simple comparisons to other business sales may suffice.

The Asset Method

The asset method values a business by adding up the sum of its assets. It’s a very predictable method of valuation; any competent accountant can look into the books, accurately assess values, depreciate them if necessary, and add them up. As a simplified example, assume a company has the following assets:

  • Property: $1 million
  • Equipment: $250,000
  • Accounts Receivable: $50,000
  • Inventory: $125,000

Assume the accountant reviewing the books calculates that $40,000 of depreciation should be applied. The valuation of the business based on this method is then:Valuation = $1 million + $250,000 + $50,000 + $125,000 – $40,000 = $1.385 million

Multiplier Methods

These methods are much more technical and apply some sort of multiplier to a specific business metric, such as EBITDA, revenue, or net income. Calculating the business metric to base the valuation is easy, but deciding on a proper multiplier for that metric is more subjective. Future market potential, competitors, product, revenue streams, potential catalysts, and risks can affect what multiplier a potential buyer is willing to accept. However, a small business owner can research previous deals of companies in the same industry to get an idea of an accurate multiplier range. In the most basic calculation, a small business owner can take an average of the multipliers from previous deals in the same industry and apply it to a chosen metric. For example, assume a business owner wants to sell his business based on EBITDA. The formula for EBITDA is:EBITDA = Operating Profit + Depreciation Expense + Amortization ExpenseNext, assume the owner finds three previous deals based on EBIDTA multipliers of 8, 9, and 5. This year, the business generated $1 million in operating profit, had $70,000 of depreciation expense, and had $30,000 of amortization expense. The estimated value of the business is:Valuation = ($1 million + $70,000 + $30,000) x ((8 + 9 + 5) / 3) = $1.1 million x 7.33 = $8.067 million

The Market Approach

This is the most subjective approach. The market approach attempts to compare businesses that are in the process of being sold and meet the following three requirements:

  • Same industry
  • Same size
  • Same geographic region

For example, a manufacturer with $1 million in revenues wants to sell. Four companies in the region have the following sales price and revenues:

  1. $2 million price, $1 million sales
  2. $10 million price, $5 million sales
  3. $975,000 price, $900,000 sales
  4. $3 million price, $1 million sales

The second company can be ignored, since it’s likely not the same size, based on its revenue. The other three can be averaged to arrive at a valuation of $1.991 million.

References & Resources

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