Knowing how to value a small business might be a steep task. Right from raising funds or applying for a loan, the small business must be valued right. Feeling confident in assessing a small business is the sole key. Let us take a leap ahead and know the fundamental ways which can help you to value small business.
Unless you are a talented businessman or an experienced one, business valuation is not a natural process. You need to understand the following things before you step into it.
The businessmen calculate SDE after which they get to know the value of their business. The SDE will compose of income report, non-cash expenses and the revenue business is generating.
In simple terms, higher is the SDE, greater will be your business value.
A stable small company which has got a consistent cash income often has substantial assets. Some of the best examples of such businesses are manufacturing along with the property.
To perform an asset evaluation, you need to understand the NBV (Net Book Value) of your business. These will give the actual figure which represents the worth of your business.
A company which has got recurring incomes needs a different method for valuation. The basic formula to calculate the worth of a recurring revenue business is as follows:
Sale value= recurring revenue x Industry Multiple
This is probably one of the most elaborate ways to value your small business. It defines the assumptions and calculates your business value.
In this method, the future cash worth is estimated by comparing with the existing cash flows. Either, you can calculate today’s revenue using the discount rate.
On an average scale, the discount rate falls between 15 to 25 percent depending on the type of businesses.
A business is only worth after someone is ready to pay for it. In this case, the intangible assets play an essential role.
If the business is working as per customer’s expectations, definitely the business value will be on the higher side. When the industry does not have a good team behind decision making, business value can go down within time.
Depending on the worth of the others, it may vary accordingly.
The valuation of a small business and a start up somewhat different than from a larger well established company.
For large and established companies we can use the methods as described before to arrive at a valuation. This can be a one of the following:
Discounted cashflow model: probably academically the most correct, but also difficult due to many assumptions to make about what cost and revenues will be in the future. In simple terms, expected cashflow in the future is discounted to today. The discount rate is a key assumption, and reflects the amount of risk.
Asset Valuation: the value of a business can be derived by valuing the assets that the company has. This is often done on the tangible assets, and may include intangible assets.
Multiples: The provide a rule of thumb. We take the profit for last year and take a multiplication factor to derive the value. A multiple of 10 means the the company is worth 10 times the profit of this/last year. For large stable companies a multiple can be as low as 5 until >100 for fast growing business in a attractive industries.
Whilst these methods work for larger, stable and established businesses, they are somewhat problematic for small businesses, or businesses that have just been started. The discounted cashflow will have too many assumptions to be realistic, the company may have very little assets, and if making a very limited profit (or even a loss) the multiple method may not work.
So is valuation derived for them.
1) Value is in the derived more subjectively; Investors and others will look at the underlying technology, potential and strength of the people to arrive at a number.
2) Simply a number is given; For most US based startups, based on comparables, the early valuation is often around $1 million - $2 million, as this is both small enough and high enough for investors and founders to start. Of course this is in the US and other countries this may well be different
3) Whatever somebody is willing to pay: Especially for smaller businesses, the valuation is what somebody else is willing to pay. Keep in mind the factors as revenues, profit, growth and risk as they will provide a direct link to that willingness.
In short, valuation is an art rather than a science - but there are certainly some rules of thumb. The smaller the business however, the more difficult it becomes to have a 'generally agreed' valuation and the more subjective it becomes.