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Four Simple Steps to Valuing Your Small Business
If you're looking for investors or want to sell your business, you must determine its value. Follow these four steps to calculate it.
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Most entrepreneurs put their hearts into their businesses; but, when it comes to putting a price tag on all that effort, nearly 98 percent of small business owners have no idea what their company is actually worth. Whether launching a venture or running a thriving operation, every owner faces that pivotal moment when knowing their real value is non-negotiable. Yet for those without a strong financial background or an expert finance team, the thought of “business valuation” can feel overwhelming.
This guide breaks down why valuation matters and walks you through a simple, four-step process to confidently estimate what your business is really worth.
What is business valuation?
Business valuation is the process of determining the economic worth of a business. This figure is critical when selling, attracting investors, planning succession, negotiating loans or resolving legal disputes. A business valuation is a powerful tool for owners, but only if it’s accurate and up-to-date.
“If you overestimate the value, you’ll scare your buyers away. If you underestimate it, you’ll leave money on the table,” said Mike Blake, founder of High Score Strategies (HSS). “But more important than the number itself is why the value is what it is. This empowers you to take action to increase the value and to negotiate with greater authority.”
If business owners cannot demonstrate their company’s worth, it becomes challenging for outsiders to determine a reasonable investment or purchase offer. It’s wise to know a business’s value before critical moments arise, such as selling, seeking capital or planning an exit.
“Whether you’re chasing funding, making deals, mapping growth or taking stock of your financial position, a solid valuation hands you both leverage and clarity,” said Holly Andrews, managing director of finance broker KIS Finance. “These prove invaluable as you expand or navigate key decisions.”
Common methods to value a business
A variety of business valuation methods exist, but most fall into three primary approaches.
Method | Best For | Data Needed | Pros | Cons |
|---|---|---|---|---|
Income (DCF, Cap Earnings) | Profitable businesses, reliable cash flow | Projected cash flows, financials | Future-oriented, factors in growth | Requires accurate projections |
Market (Comps, Precedent) | Well-established industries, sales data | Comparable sales, multiples | Real-world comparison, quick estimate | Limited private sale data |
Asset-Based | Asset-heavy, low/no profit companies | Assets and liabilities | Hard value “floor,” simple logic | Ignores intangibles, undervalues growth |
Income approach
Income approaches are best for profitable, stable, ongoing businesses. However, they’re data and projection-intensive.
- Discounted Cash Flow (DCF): This method estimates the present value of future cash flows using a discount rate that reflects risk and opportunity cost. Owners forecast cash flow over three to five years, then calculate its present value using the formula:
If the result exceeds the required investment, it signals potential value.
- Capitalization of Earnings: This technique takes current earnings (or cash flow) and divides it by a capitalization rate, which embodies expected return or risk.
Market approach
Market methods offer realistic comparisons but require public sales data, which is often hard to find for small private firms.
- Multiples Method: A market approach that assumes similar firms sell for similar prices. Find a comparable recently sold business, divide the sale price by its sales, EBIT, or EBITDA to get a “multiple,” then multiply your financials by this number to estimate value.
- Comparable Companies & Precedent Transactions: Looks at sales prices and valuation multiples from similar industry deals.
Asset-Based approach
Asset-based methods work well with tangible assets but undervalue businesses built on brand, technology or growth potential.
- Net Asset Value: Total all tangible and intangible assets (equipment, inventory, intellectual property), then subtract liabilities.
- Liquidation Value: Estimates what the business would yield if all assets were sold and all debts paid. This approach is best for asset-heavy companies or those liquidating.
How to price a business for sale
Pricing a business for sale involves more than calculation. The following steps need to be taken before selling your business.
- Prepare comprehensive, accurate financial statements: These should include your balance sheet and income statement to showcase business health and performance history.
- Consider intangible assets: Intangible assets such as goodwill, brand reputation and customer loyalty help differentiate the business beyond its tangible assets. Goodwill itself represents the premium paid for aspects like name recognition, strong client ties and talented employees, and sometimes makes up most of a company’s value in service or franchise industries.
- Review recent comparable business sales: The value of recent business sales in your sector to help determine realistic pricing and multiples.
- Consult your records: Utilize billing records, supplier contracts, documentation of recurring revenue and other evidence of stability and potential growth.
- Seek professional appraisal: Certified business appraisers can validate numbers and offer third-party objectivity, increasing credibility with buyers and investors.
- Consider market feedback: Ultimately, a business’s value is what buyers are willing to pay after seeing financials and negotiating terms. Real-world market feedback refines the price.
Tools and resources for business valuation
Technology, digital platforms, and professional services offer business owners many ways to execute valuations:
- Accounting software: Programs like Xero, QuickBooks Online, Zoho Books, and Sage 50 simplify financial statement generation.
- Online calculators: Use the free cash flow calculator and net income calculator for fast, practical estimates.
- Professional services: Certified appraisers (ASA, CVA, ABV) and business valuation consultants are recommended for sales, mergers, or complex ownership matters.
- Industry benchmarks and reports: Financial databases and industry trade groups publish multiples and market data for comparable transactions.
FAQs on business valuation
Skye Schooley and Jennifer Dublino contributed to this article. Some source interviews were conducted for a previous version of this article.
