How to Value a Small Business?

You’ve decided to sell your small business.

Are you wondering how your to value your small business?

This article gives you a beginners guide of how businesses are valued from a business owner who is also an M&A advisor.

Chapters

1. What is a small business?

2. Can a business owner value their own business?

3. How to value a small business?

4. Other factors

5. Prepare your business for sale to increase Business Valuation

What is a small business?

There are a number of differing definitions of a small business. The differences mainly stem from revenue size and number of employees.

For the purposes of this article, we will identify a small business as having a revenue of £10 million or less. This seems to be the standard across the US and the UK.

There is a greater deviation when it comes to organisation size. Employee numbers range from 50 employees all the way to a 100 employees. For the purposes of this article we will use the 50 employee definition.

The revenue to employee ratio invariably has an impact on valuation. Generally, a business that can produce £10 million in revenue with 20 employees is more valuable than a business that achieves the same revenue with 100 employees.

Can a business owner value their own business?

There are many factors that go into professionally valuing a business.

While it is unusual for a business owner to have a deep knowledge of business valuations, there are some principles an owner can use to obtain a rudimentary valuation.

This valuation can enable you to determine whether a business broker or M&A advisor is giving your business a realistic valuation. Ensuring a realistic valuation is important to a successful exit. Unethical business brokers over-value businesses that have a negative impact on the business owner and the sale. Therefore, conducting your own valuation based on these principles will protect you from over and under-valuations.

How to value a small business?

There are 2 elements to every business valuation:

1. The mathematical equation

2. The art of a valuation

This chapter introduces 2 concepts of the mathematical equation.

The first and main factor that forms the basis of a business’ mathematical valuation, is a business’ EBITDA.

EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation.

The last 3 years of business EBITDA is taken into consideration when valuing a business.

Addbacks

Business owners of small businesses usually have some level of addbacks that can be, well, added back to increase the EBITDA. These are allowable expenses that can be run through a company for the benefit of the owner. As such, they are not integral to successful operation of a company.

Some examples of addbacks are:

• Director pensions

• Private healthcare

• Vehicles (not used for business use)

There are many more. Business brokers will usually, erroneously, add back a director’s salary. While director’s salaries ‘can be’ added back, the methodology used by ‘high street brokers’ is completely incorrect. Professional business buyers (the best type) will see through that and will immediately rework the valuation. So if you are calculating your own business valuation, keep your salary exactly where it is on the P&L.

Once you have your new EBITDA figure, you can move onto the next stage of valuation.

Applying a multiple

The next step is to apply a multiple to your EBITDA.

This is where an M&A advisor’s specialist knowledge comes into play.

Many factors - from your industry’s standard multiple to business structure - affect the multiple. However, there is one principle that can be applied to give you a good idea for your business.

Before we get to the principle, let’s talk about multiples.

Small businesses usually attract a multiple of between 1.5 - 5 x.

What does this mean?

Get your EBITDA figure and multiply it by 2 or 4 or 3 or 5. This will give you your basic valuation.

So what number do you choose to multiply by?

The principle that you can use in the first instance is:

The more the business relies on you, the owner, the lower the multiple. Conversely, if the business doesn’t rely on you at all, you can use a higher multiple.

Example 1

The business owner is the main driver of sales and the general day to day manager with a team of 10 employees = 2 x multiplier applied.

EBITDA = $100,000

$100,000 x 2 = $200,000

Example 2

The business owner oversees a general manager and all other factors are the same as above = 5 x multiplier applied.

EBITDA = $100,000

$100,000 x 5 = $500,000

Even though the above examples are good guides for you, just because your business doesn’t rely on you, it does not mean a 5 x multiplier can automatically be used for your business.

This is where getting the correct training is invaluable. A small amount of education and advice can go a long way in your business sale.

Other Factors

The other factors that are considered in a business’ valuation is the art side of the valuation.

It is impossible to cover all of the ‘other factors’ that are considered in a valuation in one article, but this article does give you an idea of what an M&A advisor looks at when valuing your business.

These factors have an impact on the multiplier. They can either increase or decrease the multiplier that is used to calculate the value of your business.

Here is a list of what can be considered:

• Market

• Proprietary products/services

• Unique Selling Proposition

• Size of market

• Market positioning

• Size of customer base

The list of other factors also varies based on your industry and sector as well as the area it serves. This is why this part of the valuation is difficult for a business owner to do themselves. In fact, different M&A advisors will apply a different weighting depending on their experience in your industry or buyer contacts. Art is not math and therefore not set in stone.

Prepare Your Business for Sale to Increase Business Valuation

One of the best things a business owner can do to increase your business’ valuation is to take the time to prepare your business for sale.

You know your timeline to sale. Depending on your timeline different things can be done to prepare your business.

A basic level of preparation can be done in as little as 3 months. However, the longer you have to prepare your business for sale, the higher chance of having a positive impact on your business’ valuation.

Download the “Sell Your Business” Checklist to get ensure you can get your business “Deal Ready” and sell your business the right way.