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What is your business worth?
Remember that article I wrote about your balance sheet a while back? That’s where you can find the very literal answer to the above question.
The book value of your business, or total equity, is what your business is worth at a given moment in time. But it’s never the value used when valuing a business for purposes of a sale or investment. There are many things that need to be considered when you are valuing a business, and there are different ways of looking at it.
What follows are three business valuation methods all entrepreneurs should know.
The “textbook” valuation methods are fair market value, going concern, and liquidation value. These can be rolled up into two broader categories:
Then I want to add in my favorite business valuation method, which is really a combination of the above:
The majority of small private firms are sold as asset sales while the majority of middle-market transactions involve the sale of equity.
The reason why the valuation is needed will usually determine the best valuation approach. Business brokers can (and in most cases should) be hired to assist buyers and owners in this process.
Let’s dive deeper into each of the three business valuation methods. (Or take a look at our business valuation methods template here.)
First, before we dive into the details on the different types of business valuation methods, we’ll need to solidify what exactly a business valuation is. A business valuation is defined as “the process of determining the economic value of a business or company.” Basically, any and all business valuation methods are just ways to tell how much your business is worth—equipment, inventory, property, and liquid asset (among any other thing of economic worth your company has) included.
Business valuation methods will come in handy in multiple scenarios. You’ll, of course, need to look to business valuations methods if you’re in the process of selling your business. However, you’ll also need to consult business valuation methods for other situations, such as establishing partner ownership percentages or even in divorce proceedings.
There are many different kinds of business valuation methods out there, and some will serve you better than others, depending on your situation. That said, the following three business valuation methods that all entrepreneurs should have in their tool belt should the day come that they need them.
Market value is, perhaps, the most subjective. This method attempts to compare your business to similar businesses. This is particularly challenging for sole proprietors, because it is difficult to get comparative data. There is no public database to go by.
Broken down very simply, market value is subjective and, accordingly, will ultimately be based on a negotiation. What can you convince a buyer your business is worth?
The most common approach to market value is what is called the “income approach.” Here we seek to value a business based on multiples, capitalization rates, and discount rates (based on expected cash flow).
Can you sell your business on hype? Sure you can, but a savvy investor can see through that.
Can you sell your business on the fundamentals? Certainly, and that brings us to the asset- and ROI-based approaches.
Next up, we’ve got asset-based business valuation methods. This approach will consider your business’s total net asset value, which is the value of all of its asset, less the value of its total liabilities.
Within this category of asset-based business valuation methods are two ways to approach business valuation, so let’s break them down:
The going concern, asset-based approach looks at business valuation from the perspective of a business that is planned to continue. This is what I described above. The total equity (or assets minus liabilities). This business valuation method assumes that the business will continue on after its value is determined and that none of its assets will need to be sold off immediately.
On the other hand, the liquidation value, asset-based approach to business valuation is based on the assumption that the business is finished and won’t move forward. The net amount is what would be realized if the business is terminated and its assets sold off. The value of its assets will likely be lower than normal, because liquidation value often rounds in to be much less than fair market value.
The liquidation value asset-based business valuation method operates with a sort of urgency that other business valuation methods don’t necessarily take into account.
Now let’s look at my favorite of all the business valuation methods that all entrepreneurs should know.
First, let’s flip the script so you can understand this from a very practical standpoint. If you have ever invested in anything, what is your first and primary concern? Return on investment, or ROI.
If you buy stock in a company, you want a return. Is 25% considered good? Well, that depends on the market, right?
This is why business valuation is so subjective.
Looking at the above, let’s flip back over to valuing your business. While we’re at it, let’s go on the show Shark Tank for a minute. You can learn a lot about business valuation from watching this show if you pay attention.
The first thing a Shark Tank contestant does when they come on the show is to tell the sharks how much of an investment they want and what percentage of their company they are willing to give up in exchange. In that very moment, they are valuing their business.
Notice the sharks immediately write something on their pads. I’ve never seen their pads, but I would bet 25% of my company that, in most cases, they are writing down the valuation at 100%.
If I am asking for $250,000 in exchange for 25% of my business, then I am valuing my business at $1 million. The math is simple. Divide the amount desired by the % offered, and you have the business valuation at 100%. And with that simple statement, you’ve performed a mini business valuation right on the spot.
Now you have the rest of your pitch to convince the sharks of this valuation.
Here’s what the sharks need to know in the end:
All of these questions will inform an ROI business valuation for your sharks. If you want to learn more about this business valuation method, then listen to my short video that I’ve posted above. With this video, I take a moment to talk out and illustrate what this business valuation method looks like.
Plus, don’t forget to check out the business valuation methods template here.
There you have it, the three top business valuation methods that every entrepreneur ought to be familiar with.
Now that you’ve got an idea of your main choices, which business valuation method will you choose of ryour situation?
Whether you’re a small business or huge business, a new business or well-established business, you’re likely to find your best method of determining your business’s value through these three options.
Are you ready to determine your business’s economic value?