I recently found the following articles on business valuation. They are short and well written, and perfect for business owners and advisors with general business knowledge such as financial planners, lawyers, and CPAs. If you are a business owner or business advisor interested in learning a little more about business valuation, check out these 5 articles.
Time to Sell a Small Business
Inc. Magazine, known for it’s list of the fastest-growing private companies, candidly answers the important question: How long does it take to sell a small business? In business valuation, this issue is referred to as marketability. A number of factors determine how long it will take a business to sell and all small businesses have some marketability issues. As the article points out, it can take a year from start to finish to sell a small business. In addition, the article covers steps an owner should take to prepare for a business sale transaction. Although the article is from 2016 and the world has changed a lot since then, many of the points are still valid.
Valuing a Small Business for Sale
Nerdwallet offers some very good pointers on small business valuation for buyers and sellers. This article offers a survey of methods of valuing small businesses, including brief explanations of SDE (seller’s discretionary earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Some of these points are more high level in nature, but it also gives an overview of the major methods used in business valuation.
Asset, Income, and Market Approaches to Business Valuation
There are three approaches to business valuation. They are the asset, income, and market approaches. The three articles below provide fairly detailed explanations of each approach. Business valuators use professional judgment to select the best approach or approaches when valuing your business. However, these articles can give you a good overview of each process.
First Republic Bank writes about the basics of the asset approaches. The asset approach is used when the asset value is higher than the earnings power value of the company. Sometimes this is called the floor value because if the business no longer functions the assets will be sold off. The article gives an overview of the approach and when it might be needed.
In another post, First Republic Bank covers the income approaches. The income approach looks at the value of the business to an investor. In many cases this approach does not work well for very small businesses with values under $2,000,000. On the other hand, these are the most commonly used methods in business valuation. The article not only includes an explanation of the approach, but gives examples and basic calculations for the income approach.
Finally, the bank explains the market approach. The market approach is the most effective business valuation method for most businesses with a value under $2,000,000. This is the method most commonly used for very small business. Often with small businesses, the market approach provides the value to an owner/operator as opposed to an investor who has little to do with actual operations.
Professional Judgment is Key in Business Valuation
These are great primers on business valuation. But valuation and each of these methods require layers of professional judgment to review and adjust past cash flows and determine a likely future cash flow value. Then more judgment is required to select the correct capitalization rate or discount rate under the income methods or the correct market multiplier in order to estimate to most likely value. Besides judgment, quality data from established and reliable valuation data providers is essential for small business valuation. Certainly you may perform your own rough estimate but it is always advisable to have an experienced valuation professional value your business.
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