How to Value Your Business

Posted by: Today's Tip Contributor on December 02

Determining the value of a business can be a tricky process. But given the ongoing economic downturn, many small business owners across the nation are realizing the critical importance of understanding how to accurately assess the fair market value of their company in the event that they consider selling or want to purchase another existing business.

There are three basic approaches for determining the value of a small business.

1. Market Approach. The market approach to valuation derives business value in comparison to historic sales, earnings, and/or assets of other similar businesses. Basically the business is worth the average of what comparable businesses in the same market are worth. This can be a dangerous approach to valuation, however, if your business is not "average."

2. Asset Approach. The asset approach to valuation determines the value of a business by assessing the fair market value of its assets. The basic thought is that no one will pay more for a company’s business assets than it would pay procuring similar assets on its own. While most tangible assets are already reported on the books, determining the value of intangible assets is more difficult.

3. Income Approach. The income approach to valuation, which is most commonly used for valuing small businesses, establishes value by evaluating a business’s ability to generate economic benefit for the owner. An appraiser will start by evaluating the business’s level of earnings (discretionary cash flow, net cash flow, etc.) and then pair it with the right conversion factor (capitalization rate, discount rate or multiple, which is generally between 1 and 3 times earnings) and consider the additional value of the business’s assets to perform the valuation.

Each of these approaches serves as a foundation for a group of methods used to value a business. The one most commonly used by business brokers for the valuation of small businesses falls under the income approach and is called the "multiple of discretionary earnings method." This method is especially well-suited for valuing owner/operator managed businesses.

Accurately determining value can be a complex process and you may want to consider hiring a professional business appraiser to assist you in properly determining a value for you business.

Steve Nielsen
CEO
PartnerUp
Shoreview, Minn.

Reader Comments

DIck Stieglitz

January 18, 2010 01:49 PM

Yes, and once a business owner knows the value of their busines, they can take specific actions to increase it!Most business owners work 24-7-365 to expand their companies. But even when their companies become substantial, they continue to operate in survival mode by chasing business from any customer who will pay them. Their goal is to grow big, and a large customer base looks like an easy way to get there. To grow in ways that add value to their company, they must escape the trap of thinking and acting like a small business even though it is difficult, risky, and uncomfortable. Find more about this in my book “Expensive Mistakes When Selling a Company” (www.57mistakes.com).

John Speer

February 2, 2010 04:09 AM

@ Dick Stieglitz,

Wow Dick you seem like you know a hell of a lot more than the idiot that wrote this column. Where can I buy your book? I plan to start a small business and sell it to a Fortune 500 company or take it public within 3 years. My question - What is the best business to get into for accomplishing this?
Thanks,
John

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