3 Methods for Evaluating Your Business to Determine its Value
What is Your Business Worth?
If you’re a business owner, chances are you’ve had this question before: What is your business worth? After all, the end game for many entrepreneurs is to build a company to sell.
While you may have a great opinion of your business and think it is worth millions, the actual value of your business can be evaluated using various methods, or a combination of methods. Here, we describe three such methods.
#1 – Multiplier of Revenue, Cash Flow or EBITDA
(EBITDA = Earnings before interest, taxes, depreciation and amortization)
Using the multiplier method values the business on company financial performance. The idea behind the multiplier is to determine how long someone is willing to wait to recoup their investment. If an industry typically pays three times EBITDA, an investor paying this rate would be willing to wait three years to recoup their initial investment.
Example: EBITDA is $1 million. If the industry-standard value is three times EBITDA, the company is likely to be worth around $3 million. If an investor purchased the company for $3 million, they would expect to recoup their initial investment after three years ($1 million per year).
Note: Revenue, Cash Flow and EBITDA are very different, so a multiplier of 1 times revenue or 3 times EBITDA may result in the same value.
#2 – Perceived Value of Product or Service Line
This method is very different and more subjective than the multiplier method. If you’ve developed a software product, your company may not yet be profitable, you may not even have a lot of revenue to speak of, but if your technology is perceived to be unique or superior to competitors’ products, your company could be very valuable. There will be a value assigned to the intellectual property that cannot be calculated using an Income Statement or Balance Sheet. When this is a component of the valuation, the rate that someone is willing to pay is going to be relative to how much risk they are taking. If the product is proven and just needs some marketing and sales to get it going, the value will be higher than a product that you believe is great, but hasn’t been proven in the market yet.
#3 – Perceived Value of your Team and Company History
In some cases, an acquisition may be pursued by someone who wants your people. Due to non-competes, lack of recruiting, or other issues, an acquisition may be the only way to get them. In addition, your company history may prove to be valuable for someone. Whether it’s the reputation of a strong company name, the long-standing contracts your company has in place, or your Chief Technology Officer, the value of your company maEB increase based upon the perceived value of your team and company history. Again, this method isn’t easy to calculate using your company financials and it’s hard to compare to industry averages or standards, but you may garner quite a price for a stellar team or strong company reputation.
The value of your company may be calculated using multiple methods, including these three or others, but it is important to remember, no matter how valuable you believe your business is, it is only worth what someone is willing to pay you for it.