What’s My Business Worth?
3 Essential Approaches to Determining the Value of Your Business
3 min read
If you were asked to provide a quick estimate of the value of your company, would you have an accurate number or would you just be guessing?
There are many ways to calculate the value of a business, and the math can get a bit complicated. As a practical matter, however, your company is ultimately worth what someone is willing to pay for it.
Understanding the most common approaches buyers use to value a business will arm you with the knowledge you need to put your company on the market, buy out a partner, or get financing. Whether you are ready to sell now or just want a foundation for making careful decisions, these three methods will help you understand what factors buyers are considering when putting together an offer.
Approach No. 1 – The Asset Approach
Perhaps the most basic way to establish the value of your business is to simply add up all of your assets and then subtract your liabilities.
This can be a useful and simple approach for a business that is either very young or not yet profitable, especially if you have kept good financial records and your balance sheet is up to date.
What does your business own? Besides the obvious equipment and inventory, don’t forget to consider real estate, intellectual property, assignable contracts, and brand value or “good will”. Are you locked into a long-term assignable lease at below-market value for rent? Include it — that’s an asset with value, as well.
Even if you are not planning to sell anytime soon, regularly taking stock of the total value of your assets is a good habit to adopt. Having accurate, provable data on hand will help you take advantage of opportunities to expand your operations, especially if you need to find financing to make it happen.
Approach No. 2 – The Discounted Cash Flow Approach
For the most part, potential buyers will look at your business as a stream of cash flows, and right now smart investors are buying businesses with strong free cash flows.
In the discounted cash flow approach to measuring your company’s value, a buyer will apply reasonable assumptions to predict the future cash flows of your business for a set time period — usually 3–5 years. The buyer then takes these projected cash flows and applies the Time Value of Money (TVM) principle, which states that a dollar received now is worth more than a dollar received in the future. Future cash flows are discounted by a rate that is determined partially by the financial market at the time of valuation, and partially by certain aspects of your business.
How much less those future dollars are worth compared to present dollars depends on the risk level of the cash flows. The degree of perceived risk in a set of cash flows is expressed as a discount rate.
This discount rate is very much like an interest rate, in that the riskier the cash flows, the higher the rate and the less valuable those cash flows are determined to be. For the owner of a company, this means the riskier your business, the lower your potential offer. This is the approach used by financial institutions evaluating public companies, stock trades, and middle-market mergers & acquisitions.
Approach No. 3 – Earnings Multiples Method
At Versured, we buy small, independent insurance agencies. The market typically determines the value of our target companies as a multiple of earnings derived from comparable acquisitions of similar companies.
To help determine this value, most business brokers subscribe to a regularly updated source of acquisition data that tracks the median valuation multiples of recent transactions by industry type. We use this data to estimate the offer price for a business we are interested in purchasing.
While the earnings multiples approach is simpler than the complex equations used by financial analysts, the TVM principle still applies. This is because the median multiples are derived from repeated use of discounted cash flow analysis.
At the end of the day, increasing the value of your company through the earnings multiples method requires the same strategy as the discounted cash flows approach: to get a higher multiple for your business, you need to minimize the future cash flow risk to the buyer.
Business valuation is a complex subject, and your plate is already full running your business. So if you are considering a future exit, it helps to remember one thing – it all comes down to cash flows. The more you can minimize risk to the buyer, and the more certain the buyer can be about future cash flows, the higher the valuation multiple goes — and the bigger your exit will be.
Karen Rennick runs acquisitions and channel partners for Versured, a rapidly growing insurtech company. Her expertise spans M&A, real estate, and insurance finance.
Karen Rennick joined Versured in 2021 to head up the acquisitions team, after previously working as a business broker and a real estate professional with ProNova Partners. Her expertise spans mergers & acquisitions, real estate, and exit planning. When not running deals for Versured, she enjoys educating and mentoring entrepreneurs to help them sell their business for the best possible outcome. Karen resides in San Diego, California, with her two dogs.
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