For the past few years, Sarah has been selling dog collars that she makes at her kitchen table. Today, her pet accessories company is a thriving shop with customers all over the country.
Sarah starts her days by finding the softest leather and brightest fabrics; she spends afternoons sewing custom designs and nights managing orders and responding to customer emails. It’s hard work, and she’s turning 65 soon.
Lately, she’s been thinking about selling her business. She knows it has value, people love her products, and sales grow steadily. But what is it worth?
However, the numbers and methods are confusing when she wades into the market. One interested buyer throws out a number that seems insultingly low after glimpsing at her profit margins.
She knows her business is worth more than that, but how can she prove it?
This happens all too often.
Business owners like Sarah, who have put everything they have into their companies, usually don’t get their company’s worth when they want to sell. Other times, they don’t know what their company is worth when it’s time to sell.
In these situations, a comprehensive valuation of your company can come in handy.
What is Business Valuation?
In simplest terms, a business valuation determines how much your business would fetch on an open market. In other words, it estimates how much a buyer would be willing to pay for your business without pressure from any party concerned.
Similarly to how you would appraise your house before selling, valuing your business sets a good starting point for negotiations and ensures you are not paid less than you deserve.
Contrary to ordinary pricing, where only current earnings are factored in, this method considers all aspects of your company.
This includes tangible assets such as buildings or equipment and intangible assets like your brand name and customers, which may contribute significantly towards increasing future income through sales alone.
It also considers things like inventory levels held at any given time throughout each year, intellectual property rights owned, and so on.
Furthermore, an excellent evaluation should also touch on growth potentialities linked to different businesses and their expected rates over the years ahead.
This would give us more details about your company before deciding whether investing there could be beneficial enough.
How Do We Determine the Value of Your Business?
You’ve got to understand that valuation is not a one-size-fits-all for different businesses.
The methods we use to value a business differ based on the type and structure of the business in question. We use the two industry standards, which are SDE and EBITDA.
Let’s start with SDE.
Source: Equidam.com
If it’s an owner-operated business where the owner is actively involved in day-to-day affairs, we use the Seller’s Discretionary Earnings (SDE) multiple.
Through this strategy, we look at your annual net profit over the last three years, take the median value, and then use an industry average multiplier per the SDE chart. This gives us a range we can use to estimate how much your business is worth.
An exception to this is software as a service (SaaS) businesses, which we value using trailing twelve months of revenue multiplied by relevant industry multiples.
You must understand that SDE valuation doesn’t directly consider your industry type. The value primarily hinges on the profit your company generates.
Conversely, larger businesses with higher profits tend to command higher multiples and valuations.
When dealing with an owner-operated business, valuations usually start with a multiple of 1-2x. This reflects the higher risk of acquiring such businesses, as we will have to replace the owner to keep it running.
We also take into account liabilities that might already exist within the business because they can affect its value. Liabilities such as debts owed or legal troubles can increase the danger involved with buying and potentially decrease overall worth.
Things like projected growths for future periods, market circumstances, or how well-known brands might influence values come after we’ve looked at the business finances.
Any valuation always begins with annual net profit, a median over three years, and multiples corresponding to industry standards. The resulting range is the foundation upon which further negotiations and discussions occur.
We understand that many business owners have a specific idea of what their business is worth. However, the bottom value is determined by what someone is willing to pay.
While non-tangible assets like customer lists and social media followings may make a company more attractive, they do not always justify higher valuations if financial performance is lacking.
Our approach is pragmatic. We look at where the business has been and where it stands financially. We aim to create a win-win scenario, but you have to acknowledge that a company is valued based on what another person agrees to pay.
If your company falls short in valuation from where you want it to be, our Growth Partnership program can provide relief.
This program is not an upsell opportunity but instead acts as a flexible means by which businesses can achieve their full potential and attain desired valuations later in the future.
Now, let’s talk about the EBITDA.
Source: Pepperdine Private Capital Markets Report
Larger companies that are managed professionally and where owners have fewer hands-on roles often use multiples of Earnings Before Interest Taxes Depreciation Amortization (EBITDA). This allows them to reflect non-operating expenses such as taxes and interest.
We determine your company’s EBITDA by adding interest, taxes, depreciation, and amortization items back to the net profit before applying an industry-specific EBITDA multiple against it to estimate the value.
This depends on various factors, including market conditions, growth prospects within your sector, etc. This ratio varies widely across industries.
For example, tech firms with high growth potential may command higher multiples than traditional manufacturing companies experiencing slower growth rates.
As an owner, you should know that valuing businesses is complex and has many shades.
Why is Valuation Important?
Valuation is essential for many reasons, including:
1. Equitable bargaining: A valuation gives you a starting point for negotiation. It helps prevent underselling while justifying an asking price that is fair.
2. Knowledge-based decision-making: Being aware of the worth of your business can guide your choices about what comes next. Whether this means selling now, looking for investment, or even continuing its growth, these decisions are realized through valuations.
3. Peace of mind: Knowing where one stands regarding finances during the sale process takes away all worries and fears associated with it. You will be more confident negotiating because you have already learned everything there is to know about how much money should change hands when selling your enterprise, so what could go wrong?
What Is The Proper Range Of Reasonableness?
The “range of fairness” refers to different possible values attached to a business. There is usually not just one number but a spectrum.
These ranges depend on things like standard practice within specific industries, financial performance indicators such as profitability ratios or liquidity measurements, market conditions like bank interest rates, and the terms for which sales are contracted.
Our goal is always to find win-win scenarios within this broad range, which we believe capture every person’s needs depending on what they own and any other considerations they may have regarding their assets.
For example, some individuals want quick cash without delay, while others prefer long-term investments that include involvement even after acquisition.
Drawbacks of Poor Valuation
You have to understand that lowballing the value of your business can have some consequences:
Financial Loss: You may accept an offer much less than your business is worth. This indicates leaving money on the table and potentially missing out on the financial security you should have.
Missed Opportunities: If you undervalue your business, you might fail to attract serious buyers or investors who see its true potential. This can narrow down the choices available and impede growth opportunities.
Legal Complications: Inaccurate valuations can result in legal disputes and conflicts with potential purchasers. These could be expensive, time-consuming, and emotionally draining.
Wrap up
Alright, we’ve come to the end of this piece. You see, a good valuation of your business helps both parties decide about the future based on information rather than guesses.
A professional business valuation can provide confidence, whether you’re selling now or planning for tomorrow.
At JLM Capital, we offer an honest valuation that recognizes all the effort you’ve put into building your business. Contact us today!
