Horizon M&A Advisors

How to Value Your Business: A Beginner’s Guide for Sellers

Introduction

Understanding the value of your business is crucial whether you’re considering selling, planning for succession, or simply aiming to gain a better understanding of your company’s worth. Business valuation isn’t just about numbers; it’s about telling the story of your business’s past, present, and future potential.

Many business owners often face common issues when it comes to valuation. Overvaluation may set unrealistic expectations, while undervaluation might result in leaving money on the table. Emotional bias, where one’s attachment to the business inflates perceived value, is another frequent pitfall.

This guide will try to break down the valuation process into easily digestible steps and actionable insights. At the end, you will be able to better understand how to approach valuing your business with tips and methods explained in a very straightforward manner.

A blue desk with wooden blocks spelling VALUE, a hand adjusting a block, a cup of coffee, glasses, a pen, a calculator, and a paper with a bar graph.

What Is Business Valuation?

Business valuation is a process by which the economic value of a business or company is determined. This valuation is taken seriously for several reasons, like preparing for a sale, raising capital, or facilitating succession planning. Knowing the true value of your business can make a difference in making informed decisions and strategic plans.

Several situations are considered as mandate for a business valuation.

Examples

Selling your business: Knowing how much it’s worth helps to establish a true market value for selling.

Succession planning: Assists in making decisions as to how best to transfer the business equitably.

Raising capital or bringing in investors: It gives would-be investors an excellent idea of the company’s worth.

Divorce or partner disputes: To equitably distribute the assets it may be employed.

Understanding the different valuation methods is essential for getting an accurate estimate of your business’s worth. Here are some common approaches:

1. Asset-Based Valuation

This method calculates the total value of your business’s assets, subtracting any liabilities. It’s often used for companies with significant tangible assets.

Formula: Total Assets – Total Liabilities = Business Value

Example: If your business owns $1,000,000 in assets and has $200,000 in liabilities, the valuation would be $800,000.

Advantages: Asset-based valuation is particularly useful for businesses in industries like manufacturing or real estate, where physical assets form a significant part of the company’s value.

Challenges: Asset-based valuation may not fully capture the value of intangible assets like brand reputation or intellectual property.

2. Market Comparable

This approach compares your business to similar companies that have recently been sold. It is especially useful in industries where there are plenty of comparable businesses.

Steps

  • Identify similar businesses.
  • Look at their sale prices.
  • Adjust for differences in size, location, and market conditions.

Example: If a comparable business in your industry sold for $1,000,000 and your business is slightly larger with more stable revenue, adjustments would be made to reflect these differences, potentially increasing your valuation.

Advantages: This method provides a market-based perspective, which can be persuasive to potential buyers or investors.

Challenges: Finding truly comparable businesses can be difficult, especially in niche markets. Additionally, market conditions can fluctuate, affecting the reliability of this method.

3. Income-Based Valuation (EBITDA Multiples)

This approach looks at the income that the business will generate in the future. The EBITDA is multiplied by a factor typical for your industry.

Formula: EBITDA x Industry Multiple = Business Value

Example:If your business has an EBITDA of $500,000 and the industry multiple is 4, the valuation would be $2,000,000.

Advantages: Income-based valuation is preferred for its focus on future earning potential. It is more preferred by the investors as it gives a clearer picture of profitability and growth opportunities of the business.

Challenges:The selected multiple can range extensively based on the industry trend, economic condition, and other factors of the specific business. Proper financial projections must be done in this method.

Fact: In high-growth industries, businesses obtain higher multiples based on future profit expectations.

Factors Affecting Valuation

There are various factors that might affect the valuation of your business. Knowing these factors will help you position your company better for a higher valuation.

1. Industry Trends

The general health and trend of your industry is also one of the important factors. Tech companies, for instance, command higher multiples because of their growth potential.

Example: A booming industry with high demand is likely to fetch a premium price. On the other hand, an industry facing a decline might lower the value of the business.

Consideration: Regulatory changes or technological advancements are also external factors that can influence industry trends and thus your business valuation.
To understand how it would impact your business valuation, stay updated on industry trends and market conditions.

2. Financial Health and Profitability

The most important indicators of the value of a business are consistent profitability and good financial health. Keep your financial statements clean and accurate.

Key Metrics:

  • Revenue growth rate
  • Profit margins
  • Cash flow stability


Example: Consider a retail business with steady revenue growth of 10% year-over-year and profit margins consistently above 15%. This financial health would make the business attractive to buyers, potentially increasing its valuation.

Consideration: It’s important to account for any seasonal fluctuations in revenue and expenses, as these can impact the perception of financial stability.

3. Customer Base and Contracts

A diversified and loyal customer base can add value. Long-term contracts with key customers are stable and predictable.

Example: A company with a few large, long-term contracts may be valued higher because of the predictable income stream compared to a company with a more volatile customer base.

Consideration: Customer concentration risk, where revenue is highly concentrated in a few customers, hurts valuation. This risk can be mitigated by diversifying the customer base.

4. Intellectual Property or Patents

Valuable patents or proprietary technology can significantly increase your business’s valuation.

Fact: Companies with patented technology or exclusive rights have a 20-40% increase in valuation over those who do not have these.

Example: A software company, having a unique algorithm that has been patented, may be eligible for a higher premium valuation on account of competitive advantage and licensing revenue.

Consideration: Ensure your intellectual property is well-documented and legally protected to maximize its contribution to your business’s valuation.

How to Begin with Valuation

Getting started with valuing your business may sound overwhelming, but breaking it down into manageable steps can make this seemingly time-consuming process much simpler.

1. Collect Financial Files

Obtain all financial documents, such as balance sheets, income statements, and cash flow statements, all of which are important for all valuation methods.

To-do list:

  • Three years financial statements
  • Tax return
  • Account receivables and payables statements
  • Inventories

Ensure that your financial records are accurate and up-to-date to give a clear picture of your business’s financial health.

2. Intangible Assets

Intangible assets such as brand reputation, customer loyalty, and intellectual property can add value. List them and consider how they contribute to your business’s success.

Examples:

  • Brand recognition
  • Proprietary technology
  • Trademarks and copyrights

Documenting and quantifying intangible assets can help demonstrate their value to potential buyers or investors.

3. M&A Advisor

Professional advice is always the best. Horizon M&A Advisors, for instance, specializes in helping business owners understand and maximize their valuation. You can ensure no critical aspect is overlooked with their expertise.

Action Plan

  • Schedule a consultation with an M&A advisor.
  • Discuss your business goals and valuation objectives.
  • Develop a valuation strategy tailored to your business.

Fact: Engaging professional M&A advisors often brings 10-15% more valuation to the businesses because of strategic insights and negotiation skills.

Conclusion

Accurate business valuation is essential in making the right decisions, especially when selling, transferring ownership, or attracting investors. Knowing the various methods of valuation and the factors that affect your business’s value will help you position yourself for success.

Remember, an accurate valuation not only reflects your business’s current worth but also its future potential. Regular valuations can help track your business’s growth and identify areas for improvement.

If you are ready for the next stage, call or contact Horizon M&A with your request to have a business valuation. We will keep guiding you along every step towards making the process result in giving you the most successful outcome as far as selling your business.

Scroll to Top