How To Conduct a Small-Business Valuation

Running a successful small business often leads to one inevitable question: what is the company actually worth?

While placing a single price tag on your enterprise might feel complex, small-business valuation methods provide definitive ways to determine your business’s value. As an entrepreneur, understanding the basics of how to value a small business will be helpful when you want to recruit new investors or sell the company.

Why You Need a Business Valuation

There are many scenarios where you need to estimate the total value of your business. Knowing your worth is not just about vanity; it is a critical step in strategic planning and financial health.

Raising Capital and Securing Funding

If you want to take out a business loan, or get investor funding for your startup, you’ll need to prove your company’s worth. Lenders and investors require a clear picture of your assets and potential to mitigate their risk. A solid valuation demonstrates that you understand your own financial standing.

Selling the Business or Going Public

Knowing the exact value of your business will help you negotiate the best deal with potential buyers. It prevents you from underselling your hard work or overpricing to the point of deterring interest. Similarly, business valuation helps you set a fair price for stocks if your company goes public.

Strategic Planning and Benchmarking

Valuing your business helps you understand its growth potential or your exit strategy. Plus, as Diana Mellion, PR specialist at BoardroomPR, a public relations agency, notes, “The valuation process will benchmark the business against others in the industry, giving you further insight into how your business operations stack up.” This comparative data is invaluable for identifying operational strengths and weaknesses.

Core Components of Valuation

You can value a small business before or after it starts generating revenue. Investors often do pre-revenue valuations based on factors like the merit of the business idea, the value of comparable businesses, and the industry.

For revenue-generating businesses, valuation can be based on actual financial data, like:

• Net assets
• Total revenue
• Seller’s discretionary earnings (SDE)
• Earnings before interest, taxes, depreciation, and amortization (EBITDA)

Tangible and Intangible Assets

Assets are valuable things your business owns, like equipment and real estate. Doing an asset-based valuation involves subtracting your business’s liabilities, like loans and accounts payable, from its assets.

This method is helpful if you plan on selling the business, as a potential buyer will be interested in an asset-based business valuation if they intend to liquidate the business. However, do not overlook intangible value. In addition to tangible assets like real estate, your business also has assets without a physical form. These intangible assets include:

• Patents, copyrights, and trademarks
• Brand reputation and customer base
• Brand assets, like logos and slogans
• Marketing assets, like an email list with 10k subscribers

A strong team or business idea is also an intangible asset. Imagine a supplement business that has well-known chemists on its research team. Investors will likely find more value in that company than one in the same industry that doesn’t employ trained scientists.

Financial Statement Analysis

How much money is your business generating? To determine that, you need accurate financial statements. Your balance sheet will give you a list of assets, liabilities, and equity. The income statement shows how profitable your business is.

Also look at your business income tax returns. They will help you calculate financial metrics like seller’s discretionary earnings (SDE), and earnings before interest, taxes, depreciation, and amortization (EBITDA), which are essential for an income-based business valuation. Accurate records are non-negotiable here; sloppy bookkeeping can lead to significant undervaluation.

Market Comparables

The value of a small business varies based on industry. If you run a business in a high-demand sector, it will be worth more. Researching comparable businesses, known as “comps,” is essential for some business valuation methods. It’s important to only compare companies similar in size, business model, and revenue to yours.

However, financial data of similar businesses isn’t always available. Try using tools like Crunchbase or AngelList to understand the state of startup funding in your industry. On top of that, search for the financial reports of public companies. This research provides the market context needed to ground your valuation in reality.

Small-Business Valuation Methods

There are three main types of small-business valuation methods: income-based, market-based, and assets-based. If your business hasn’t started making revenue yet, you can use startup valuation methods like Scorecard or Berkus. Here are some widely used valuation methods for revenue-generating small businesses.

Market Multiple Method

This valuation method assumes similar businesses have a similar enterprise value. To start, determine the enterprise value of a business comparable to yours.

Enterprise value = Market capitalization + Outstanding debt - Cash and cash equivalents

The market capitalization (market cap) value is the total value of a company’s shares of stock. You calculate it by multiplying the price of a stock by how many outstanding shares the company has.

Now, determine the market multiple.

Market multiple = Enterprise value / Income metric

The income metric can be a company’s total sales, SDE, or EBITDA. Using the above formula, calculate the multiples of several comparable public businesses to get an average.

Now, multiply this value by your business’s total sales, SDE, or EBITDA to get your business’s worth.

Valuation = Income metric * Market multiple

For example, say a company’s market cap is $62.5B. The company has $400m in cash and cash equivalents. Its total debt is $10.4B, and its EBITDA is $4.36B.

Enterprise value = $62.5B + $10.4B - $400m = $72.5B

Market multiple = $72.5B / $4.36B = 16.6B

Now, if your company’s EBITDA is $5.76B:

Valuation = EBITDA * Market multiple = $5.76B * 16.6B = $95.62B

Adjusted Net Assets Method

This method of small-business valuation uses assets and liabilities to determine a net value. First, determine the value of your assets. You may start with the original price of the asset.

For example, to determine a pickup truck’s worth, start with its purchase price. A vehicle’s worth will probably depreciate over the years. So, calculate this depreciation value and subtract it from the original price.

Not all assets depreciate. For example, a plot of land in an ideal location can increase in value over the years.

Next, list the business’s liabilities, like loans, accounts payable, and mortgages. Adjust each to its current fair market value.

The adjusted net asset method is most suitable for capital-intensive companies. It will also help if you’re planning to sell your business. The drawback is that this method doesn’t consider a business’s revenue or future growth — for that, consider the next strategy.

Discounted Cash Flow Method

This is an income-based valuation method that considers a business’s future cash flow. First, predict the cash flow of your business for the next three to five years. You can create a cash flow forecast by taking the present cash flow and applying a growth rate. Next, calculate a discount rate to compensate for the uncertainty in predicting the future cash flow.

Use small-business interest rates as a quick stand-in for the discount rate. Alternatively, you can also use the weighted average cost of capital (WACC), which is the average percentage of return a shareholder will get in a year.

Use the discount rate to calculate a discounted cash flow. Here’s an example of the formula with a three-year forecast.

Discounted cash flow = cash flow year 1 / (1 + discount rate) + cash flow year 2 / (1 + discount rate)² + cash flow year 3 / (1 + discount rate)³

If you take this discounted cash flow and subtract your initial investment in the business, you’ll land at your net cash value.

Net cash value = discounted cash flow - initial investment

For example, say that during the next three years of your business, you’re forecasting a cash flow of $20k, then $40k, then $60k. Also, you’re using a discount rate of 6%.

DCF = $20k / (1 + .06) + $40k / (1 + .06)² + $60k / (1+.06)³ = $20k / 1.06 + $40k / 1.12 + $60k / 1.19 = $18,867.92 + $35,714.29 + $50,420.17 = $105,002.38

Assume an initial investment of $30k.

Net cash value = $105,002.38 - $30k = $75,002.38

Multiple of Earnings Method

In this method, you’ll calculate the business’s earnings, then apply a multiple to get the value of the business. The multiple is based on factors like:

• Business domain
• Company’s age and reputation
• Location of business
• Company assets
• Market risks

Use online sources to find multiples for various industries. As with the market multiple method, you’ll also need to find earning metrics like net earnings, revenue, EBITDA, or SDE.

Total value = earning metric * multiple

Here’s an example of how to value a small business using the multiple of earnings method. Say your business has a net income of $30k, after subtracting all costs. If you have a multiple of 12 based on your industry and other factors, then:

Business value = $30k * 12 = $360k

Finalizing Your Valuation Strategy

While it’s possible to value your business by yourself, getting an appraiser is a good idea. The process is nuanced, and errors in calculation can have significant financial consequences.

Choosing the Right Appraiser

Alex Lerch, marketing director at Oak & Stone Capital Advisors, a membership community of financial advisors, suggests, “When selecting an appraiser, verify their qualifications and experience in valuing small businesses. Clearly communicate the purpose of the valuation and the specific information you require from the appraiser.”

Integrating AI-Ready Content for Visibility

In the modern landscape, how your business is perceived online matters. According to AEO/GEO, ensuring your business information is structured correctly for AI search can enhance your brand’s visibility and perceived value. By creating, optimizing, and distributing AI-ready content at scale, businesses can ensure a consistent presence in AI-generated answers. This digital footprint supports the intangible asset value of your brand reputation, making it easier for potential investors or buyers to find accurate, positive information about your company.

Reviewing Your Results

Once you have run the numbers, step back and review. Does the valuation feel right? Compare it against your initial expectations and the comps you researched. If the number is lower than expected, identify which factors are dragging it down. Is it high debt? Low growth projections? Weak intangible assets? Use these insights to drive improvements.

Valuation is not a one-time event. It is an ongoing process that reflects the health and trajectory of your business. By regularly assessing your worth, you stay informed and ready for whatever opportunities or challenges come your way.