Valuing a privately held business can seem daunting when you consider all of the possible methods of valuing a company. Outlined below we briefly discuss the most common types.
1) Asset Value
Usually only applies where the asset values exceed values based on income. Examples are companies that are either struggling financially or have an excess of assets relative to the revenue generation of the business. Rarely used in valuing a business for sale. Even struggling businesses sometimes have goodwill or other intangible assets that a buyer may pay extra. Assets considered will include equipment, fixtures, inventory, accounts receivable, open orders, customer lists, patents and other intellectual property.
2) Discounted Cash Flow
a) Discounted cash flow is often used by professional buyers when determining the amount they want to pay for a business. Basically this calculation is the present value of future cash flows of the business. Many factors go into the calculation and each of the factors requires making assumptions and judgements. Most importantly there are three data points to be decided:
i) Cash flow for each year into the future โ usually 5 โ 10 years.
ii) Discount rate used to value future cash flows in todays value. A few percentage points in either direction with the discount rate can have a large impact on the calculated value.
iii) Future sale value โ what will the business sell for at the end of the time horizon.
3) Multiple of EBITDA
a) EBITDA is earnings before Interest, Taxes, Depreciation and Amortization. The most common form of valuation in the middle market of M&A, particularly for businesses with at least $500,000 of ebitda. Using transaction data relevant to the business and industry a multiple, say 4x is applied to the adjusted ebitda to come up with a price. Sometimes criticized because it does not consider taxes and capital expenditures, it is nonetheless an important method to use as a starting point for buyers, sellers and advisors.
4) Multiple of SDE
a) Similar to Multiple of EBITDA, but SDE which stands for Sellers Discretionary Earnings, includes the owners normalized salary and benefits. This is most often used in small business transactions where the owner is the key manager and the buyer is likely to be an individual who will replace the owner. Multiples of SDE tend to be lower than multiples of EBITDA but the resulting value could be the same for many businesses.
5) Multiple of Revenue
a) Multiples of revenue are often quoted but almost never used by professionals except in some unique circumstances. Buyers and lenders are interested in cash flow much more than revenue. For instance, a manufacturer with $5 million in sales and $1 million of gross profit is going to be of much lower value than a company with $5 million in sales and $2.5 million of gross profit, yet a multiple of revenue calculation will show both companies as being of equal value.
Valuation of a business includes financial calculations, but other factors are also important including number and type of potential buyers, terms, and the unique characteristics of your business.
See more on our Business Valuations page.