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How is a Small Business Valued?

business valued

Here are some insights into my new CEPA designation or Certified Exit Planning Advisor. When it comes to owning a business, it’s been stated that 80-90% of our net worth is tied up in our business. Many times business owners will go out and hire an investment advisor, pay them 1% to manage small portion. Yet, we’ll look all around trying to figure out how to grow the value of your business.

So what I’m showing you today is something you’ll want to tuck away to help you when you do sell your business. Because as a business owner, we want to grow the businesd so that at any time we can sell it. Let’s look at how a business is valued and how to drive that value up. THIS IS NOT VALUATION 101! This is just a simplified version of what CPAs can do to place a value on you greatest asset.

First, understand that there’s a bell curve. Most businesses sell with a multiple. Within the bell curve, there’s a rule of five. The average multiple most business sells for is five times. On the left side of the curve, we have 1-4 times, and on the right side, we have 6-10 times. So how is the business value derived from this curve?

Cash/Sales X Multiple = Value

With the multiple being the key (the number from the bell curve), then the question becomes, how do I get my multiple greater than five? And the second question is how do I deal with my cash/sales?

It all comes down to a term used in the accounting world EBITDA (this is the cash/sales figure for our formula). EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. The simple way to look at this is you take the gross earnings you make, deduct your expenses, and add back some numbers. You add back your taxes, your depreciation, and your amortization and that gives you the value.

The business factor model looks like a linear equation. We have tangible assets and intangible assets. The biggest factor when it comes to moving the multiple is the intangible assets. Those come in four different flavors.

1. Human Capital
2. Customer Capital
3. Structural Capital
4. Social Capital

These four Cs will determine your multiple and up your value.

If your EBITDA is $100k and your multiple is 2, then your business is worth $200k. However, what if through planning, (this is where your planner comes in) you can drive your multiple up to seven, the that $100k is now $700k. If you continue working on your intangible assets moving your EBITDA up to $200k, then your business with a multiple of seven is now worth $1.4 million.
This is what a CEPAs deal with. Growing and positioning your business value for maximum sales price.

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