Small business owners face many challenges, but valuing a company is often at the top of the list of challenging tasks. Why? How can an owner put a price tag on years — or decades — of hard work? Of course, these small business owners must balance their emotions with what the market will reasonably pay.
Chances are you're asking this critical question: What is my business worth? While there's no perfect way to figure out this number, there are several methods you could use to help you determine the fair market value of your company. Understanding these small business valuation methods could help put you in a more knowledgeable position when it comes time to grow the business, seek outside investors or take out a business loan.
What Is My Business Worth? The Value of Understanding
Do you want to sell an equity stake in your small business to an investor? Do you want to bring on a partner — who you would then compensate with a mix of salary and shares in the company? If so, you'll need to have a baseline from which to do these calculations, and that baseline is your business's valuation. (You can't really offer someone a stake in something when you don't know what that something is worth.)
Your small business's valuation could also be important in getting a bank loan. Lenders tend to look at a company's cash flow and assets to determine its ability to repay a loan. Both of these things factor into how a business is valued. Depending on the size of your business, a bank may want to do a valuation before it lends you money. Having this information on hand to make your case could put you in a better position to get the loan you need.
Another reason to understand your small business's value? In life, anything can happen. If you suddenly become unable to run the day-to-day business operations or pass away unexpectedly, knowing your business's value could help you (or your loved ones) make informed decisions about what to do next. These options could include selling the company or keeping the company if it has a high valuation, positive cash flow and wealth-building potential for your family.
As the saying goes, knowledge is power — and knowing your company's value is one way to empower yourself as a small business owner. Here are four business valuation methods that could help you take the first steps toward understanding the worth of your small business.
1. Start With Your Business's Assets
One of the simplest ways to value your small business is similar to how you'd calculate your own net worth: assets minus liabilities. Assets are anything that have value and can be converted to cash, such as property, equipment or proprietary products that are unique to your company. Liabilities include any debts you owe. For example, if your business has $1 million in assets and $250,000 in liabilities, its value would be $750,000.
Using an asset-based approach to business valuation could be a good option when other valuation methods result in a lower value for your business. However, this approach doesn't take into consideration intangible things like your company's reputation or brand — both of which could lead potential buyers or investors to place a greater value on your business.
2. Look at Your Cash Flow
This method determines a value for your small business based on its estimated future cash flow. Potential investors often ask entrepreneurs to provide information about their current and future profits. Investors use this number to determine how much the business could sell for in the future — minus how risky the investment is and how much it'll cost them to get the capital to invest.
This method is called the discounted cash flow analysis, and it often involves a lot of educated guessing based on estimates and projections. If those projections are off or unrealistic, your business might end up being under- or overvalued.
3. Use Revenue or Earnings as Your Guide
Looking at your small business's revenue or earnings are two other ways to determine its value. Like an asset-based approach, these methods are a relatively simple (and sometimes rough) way to figure out a business's worth. You can multiply your business's revenue by a certain numeral based on your industry to come up with the value. For example, if the industry standard is "three times sales" and your revenue for last year was $500,000, your revenue-based valuation would be $1.5 million.
Multiplying your earnings, or how much your business makes after subtracting its costs, is another valuation method. It requires making projections about the business's future earnings and using a multiple to come up with a valuation. Of course, every business goes up and down throughout the years, which is why using revenue and earnings as a baseline is not a perfect science.
4. Compare Your Business to Others in Its Industry
Every business has competitors, so looking at the sale price of comparable companies with a similar customer base and revenue can help you ballpark how much your small business is worth.
Along with sale price, you could try to find public information about the valuation of comparable companies. This strategy can be more challenging to complete with smaller businesses or private companies. Another disadvantage is that there's no way to make an exact comparison — so using your business' assets, cash flow, revenue or earnings may be a little more precise.
Regardless of which valuation method you choose, it's helpful for small business owners to know the worth of their company. Consider enlisting help to determine your business's valuation and tackle some of the many challenges of owning a small business. Having a firm grasp of your company's financials could help give you a better idea of your business's value should you ever decide to take on an investor, sell the company or pass it along to future generations.