How is a Small Business Valued?

When it comes to owning a business, it’s been stated that 80-90% of our net worth is tied up in our company. Many times business owners will go out and hire an investment advisor and pay them 1% to manage a small portion… with the business not included in this mix. Yet, investment advisors often don’t include your biggest asset – the business. We must have an understanding of exactly how a small business is valued so as to add it into the overall wealth planning process.

What I’m discussing today is something you’ll want to tuck away to help you value and eventually sell your business. Let’s look at how a business is valued and how to drive that value up using insights from the angle of a CEPA (Certified Exit Planning Advisor). THIS IS NOT VALUATION 101! This is just a simplified overview of what CPAs can do to place a value on your greatest asset.

First, to understand how much a business is worth, we must understand how it is calculated. The business’s value is assessed by the following formula:

Value = Cash and Sales x Multiple

This value is calculated as your income times the multiple. “Multiple”? This number begins with an industry-specific range based on many factors… but let’s use a hypothetical and say your industry’s average multiple is five.

This means we have a number of businesses will sell for less than the average, 1-4 times, and ones that sell for 6+ times. Knowing that the higher the multiple, the higher the value, the multiple is key to helping (or hurting) valuation.

Then the question becomes, how do I increase my multiple? And the second question is what part do intangible assets play? 

Let’s start with income. This real number all comes down to a term used in the accounting world EBITDA which 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 other numbers – your taxes, your depreciation, and your amortization. That gives you a value.

Now to the intangible assets. The biggest factor when it comes to moving the multiple is improving intangible assets. They come in four different flavors – human, customers, structural, and social.

The Four Cs will help determine your Multiple:

1. Human Capital – your staff
2. Customer Capital – the number and diversity of your customers
3. Structural Capital – your systems that run and track your business
4. Social Capital – how your business is perceived by the public

IN-DEPTH READING: The Four C’s – the Intangible Asset that Drives REAL Value to a Business

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, then that $100k is now $700k. If you continue working on your intangible assets and moving your EBITDA up to $200k, then your business with a multiple of seven is now worth $1.4 million.

This is what a Certified Value Growth Advisor and a Certified Exit Planning Advisor will deal with, growing and positioning your business value for the maximum sales price.

To learn more about increasing your Multiple, head into our Building a Sellable Business series where we discuss ways to grow the Four C’s in-depth.