how to value a small business

Valuing a small business involves several key steps and methods. Here's a concise guide on how to value a small business:

1. Understand the Purpose:

   • Decide why you are valuing the business (selling, securing funding, partnership, etc.).

2. Gather Financial Information:

   • Collect detailed financial records including income statements, balance sheets, cash flow statements, and tax returns.

3. Choose Valuation Methods:
   There are multiple ways to value a business, often used in combination for accuracy:

   • Seller’s Discretionary Earnings (SDE) Multiple : Common for small businesses; calculates total financial benefit an owner derives annually. SDE includes earnings plus owner’s salary and perks.
   • Discounted Cash Flow (DCF) : Projects future cash flows and discounts them to present value, accounting for risks. Useful for startups or growth businesses.
   • Capitalization of Earnings : Values business based on expected future profits assuming steady earnings.
   • Asset-Based Valuation : Values the business by subtracting liabilities from total assets.
   • Market-Based Approach (Comparable Sales) : Compares the business’s value to similar businesses recently sold.
   • Price/Earnings Ratio : Multiplies business earnings by an industry standard multiple.
   • Return on Investment (ROI) Method : Uses net profit and desired ROI to calculate business value.

4. Calculate Seller's Discretionary Earnings (SDE):

   • Add back owner's salary, benefits, one-time expenses, and non-essential costs to net profit.

5. Apply Multiples According to Industry Standards:

   • Industry-specific multiples reflect market conditions, risk, and location.

6. Consider Market Factors:

   • Analyze similar businesses, market trends, and economic conditions affecting value.

7. Seek Professional Advice:

   • Valuation experts or accountants can provide accurate appraisals and help select appropriate methods.

Example: For a small business, calculate SDE and multiply by a typical industry multiple to get estimated value. Or, forecast future cash flows and discount them using a risk-adjusted rate for valuation. An accurate valuation helps in setting a fair sale price, negotiating with buyers, securing financing, and strategic planning. In summary, valuing a small business integrates financial analysis, market comparison, and method selection tailored to the business type and purpose.