1. Prepare the financial statements and determine the SDE.
All valuation methods hinge on financial performance, so the first step is preparing the company’s financial statements. Gather financial records for the past three years, including:
- Income statements
- Cash flow statements
- Balance sheets
- Tax statements
If the business hasn’t been operating for three years, consider using a projection model
Next, work with your accountant to transform the income statement into a seller’s discretionary earnings (SDE) statement, which adds back non-recurring purchases and discretionary expenses to more accurately reflect the cash flow to the owner. These expenses include the owner’s salary and personal expenses, travel that’s not essential to the business, charitable donations, leisure activities, and one-time expenses like settling a lawsuit.
2. Gather “comps” of listed and sold businesses.
Recent sales of comparable businesses (or ‘comps’) are a popular valuation rule of thumb that will offer you a realistic picture of what similar businesses are selling for. By identifying examples of similar businesses that have sold in the same area, you can get a better sense of a realistic selling price. These are also a source of data for finding an appropriate market multiple.
Comp data can be accessed through several online sources, as well as through a business broker such as Royal Business Consultants, who can help to provide you with additional market insights.
Read here: Thinking about Selling Your Business? 10 Key Questions Every Business Buyer Wants Answered
3. Know When to Engage a Professional
Business owners and buyers have many tools at their disposal to gauge the market and determine a fair value for a business, but it’s important to consider enlisting professional help, especially as values increase. Self-valuation may be appropriate when buying or selling businesses under a couple hundred thousand dollars, but as values increase, so do the risks of over/undervaluing.
Hiring a professional business appraiser or business broker not only allows you to benefit from their expertise, but it also provides the objectivity that you may lack when it comes to making a fair assessment of the business. Many brokers are experienced at conducting a formal valuation or have connections with qualified appraisers. A qualified professional should have the designation of Accredited in Business Valuation (ABV). Accountants who have earned this certification are required to pass an exam administered by the American Institute of Certified Public Accountants (AICPA). In addition to the exam, these specialists must meet business experience and education requirements to be certified.
Valuing a business correctly is essential in a competitive market, and enlisting the help of a third-party professional will not only eliminate seller sentiment from the sales process, it will also shorten it by aligning the business value with up-to-date market conditions.
Next Steps
Valuing a business requires a multilayered approach, so owners combine more than one business valuation method to get to a realistic range. Most small businesses start with an SDE multiple and add more analysis based on sales, cash flow, and growth trends. All these factors combined will give you the most accurate business valuation. Call Royal Business Consultants to discuss how your business can be properly valued as you consider a sale within the next 6 – 12 months