Business Guides

3 Valuation Methods Small Business Owners Need to Know

Last updated on February 15, 2021

Jacques Famy Jr

Have you recently been considering selling your business? What about looking for new investors or buyers? Are you applying for an SBA business loan? You’ve likely heard of business valuation and its vital role in determining your company’s economic worth. No matter your reasoning for performing a small business valuation, it’s essential to account for the various methods business owners utilize to value a company based on its size and underlying valuation purpose. Many small business owners decide to work with a professional appraiser or business valuation expert. However, it’s incredibly beneficial for your company’s future to understand the business valuation process and popular methods used by small business owners around the country.

So, What Is Business Valuation?

The process in which a business owner identifies the economic worth of a company is business valuation. There are various methods small business owners can utilize to assist them in evaluating a company’s value. However, some are more effective and popular than others. Regardless of the valuation method you choose, it’s essential to know that your business’s full and objective assessment will be required. Below are a few factors that are included in all business valuation calculations:

  • Equipment worth
  • Inventory
  • Property
  • Liquid assets
  • Management structure
  • Projected earnings
  • Share price
  • Revenue

Why Is It Important?

Business valuations can be time-consuming, but your personal and professional lives are closely intertwined as a small business owner. Thus, there are many reasons why small business owners may choose to evaluate the worth of their company.

  • Selling your business
  • Adding shareholders
  • Tax purposes
  • Buying out other owners
  • Establish a further understanding of your business’s growth
  • Offering employees equity
  • Divorce proceedings
  • Applying for a short-term business loan
  • Merging with or acquiring another company
  • Establishing partner ownership percentages
  • Seeking a business line of credit
  • Attracting investors

How to Prepare for a Business Valuation

At times, business owners choose to conduct a business valuation for informal purposes. If this is the case, it may be easier to complete one on your own. However, if you’re choosing to conduct a business valuation for more serious matters like selling your business or applying for a business loan, hiring a professional appraiser or business valuation expert may benefit. Below are a few recommendations to help you prepare for completing a business valuation:

  1. Organize Financial Documents. When completing a business valuation for your company, it’s essential to be aware that the results will be based in part on your business’s finances. When preparing for a business valuation, the previous three to five years of tax returns and financial statements will be required. Financial statements can include but are not limited to balance sheets, income statements, cash flow statements, sales reports, and industry forecasts.
  2. Gather Other Essential Paperwork. Business owners choose to get a business valuation for various reasons, meaning it may be necessary to compile other essential documents like business licenses, deeds, permits, certifications, and any ongoing contracts. These documents are particularly applicable for business owners planning on selling the business or applying for business loans.
  3. List Additional Intangible Assets. Like how your company’s tangible assets like cash, property, and equipment will be accounted for on your balance sheet, it’s just as important to list any intangible assets that may be providing value. Take some time to think outside the box regarding intangible assets, as positive online reviews or high ranking in SERPs can also improve your business’s valuation as each helps you attract and retain customers.

Popular Valuation Methods for Your Small Business

Once you’ve decided upon completing a business valuation and have adequately prepared, it’s recommended to become familiar with the various valuation methods available to you. While there are many, small business owners may find specific valuations more beneficial than others – especially when considering your unique situation.

Market Value Business Valuation Method

If you have access to up-to-date market data on your industry competitors, utilizing the market value valuation method has proven to be one of the most subjective approaches to measuring a company’s worth. By choosing to use the market value business valuation method, your business’s value will be determined by making a comparison to similar companies in your industry that have sold in the past. Unfortunately, this method can be challenging for sole proprietors as it can be difficult to find comparative data that’s realistic since sole proprietorships are individually owned.

Since market value business valuation can be imprecise, you can expect your company’s worth to be based around negotiation – convincing a buyer of your company’s worth may be simple, but gaining investors could be challenging. If your goal is to understand your company’s worth, the market value business valuation method is excellent. Still, you will likely want to utilize a more thorough and truthful approach in the future before going through with a sale.

ROI-Based Valuation Method

The ROI-based valuation method is quite simple as you will determine your company’s value solely based on profit and what kind of return on investment (ROI) potential investors could receive for buying into your company. Investors usually want to know what their ROI will look like before deciding to invest, making this method very practical. However, markets in every industry can change at any time, meaning the determined ROI varies depending on current market performance. Suppose you choose to utilize the ROI-based valuation method. In that case, it’s also not unusual for inquiring investors or buyers to need more information before deciding to move forward with your company, like what length of time it will take before their original investment is recovered.

Asset-Based Valuation Method

At times, small business owners decide to determine their company’s worth with the asset-based business valuation method. Instead, you will take your company’s total net asset value minus the value of total liabilities found on your balance sheet. The going-concern and liquidation value asset-based methods are the way to approach asset-based valuation. If you plan to continue operating your business and not sell any of your assets immediately, the going-concern approach will be most beneficial. Here, you’ll take account of your company’s current total equity (assets minus liabilities). If your business is finished and your assets will be liquidated, the liquidation value asset-based approach will be most beneficial. Here, you’ll determine your company’s value based on the net cash that would be available in the event your company is terminated and all assets were sold. It’s essential to keep in mind that the value of your company’s assets may be significantly lower than usual, as liquidation value typically equates to much less than fair market value.

Regularly Valuing Your Small Business Is Beneficial

Maybe you’re not planning on selling your business or applying for a business loan in the foreseeable future. Even still, there’s value behind studying the various valuation methods small business owners utilize. There are many ways to determine your company’s value; becoming familiar with the methods most used by small business owners should be your first step. Learning how to estimate your company’s value will give you a realistic understanding of your company’s worth, help you identify any areas of improvement, and help you track your company’s progression over any given time frame.

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