If someone were to ask you how much your small business was worth right now, could you tell them?
Maybe not. After all, there are so many other pressing things for you to do that understanding the value of your business is less important, whether you intend to sell one day or not.
But when it’s time to understand your competitive advantage, your market share, and your approach to funding, knowing your business’s valuation is really helpful.
Luckily, it’s simple to calculate and we can show you how.
Why you need to know how much your business is worth
As a business owner, the most obvious reason for finding out the value of your small business is if you’re looking to sell.
But it's also an important thing to know when securing funding because it lets you know what equity in your business is worth when pitching to investors or planning to take on debt.
Even if you don’t have plans to sell or a burning need for capital, things can change quickly and it’s always better to be prepared! Knowing your business’s valuation is also useful for buying out partners, offering employees equity, or for any other reshuffle of shares.
While your business valuation has many uses and applications, it primarily:
- Indicates your business’ financial health
- Demonstrates your impact to funding providers and lenders so you get better rates and see less dilution
- Helps you develop your longer-term financial strategy
How to value a small business
You have two options when you’re determining the value of your business. You can take it on yourself, or you can hire a professional appraiser or accountant to do it for you. Luckily, there are other companies that have built a white label job board which can help you find the right talent in no time.
Although this article will help you understand the process of valuing your small business, we recommend you speak to a professional who takes the time to understand your unique set of circumstances.
However, if you choose to calculate it on your own, be sure to stay objective and don’t let emotions influence your valuation. You’ll need to explain this business valuation to stakeholders like investors or buyers so make sure you’re able to back up your calculation.
Here are the steps you’ll need to take as a business owner preparing to value your business:
Prepare your paperwork
Start by getting your financial documents together and identifying business assets.
This includes profit and loss statements, tax filings, and balance sheets from the last 3-5 years. You’ll also want to prepare supplemental documents about your business such as licenses and deeds.
While it’s important to prepare all tangible assets, don't forget to identify your intangible assets as well. These add value to your business and can include copyrights, patents, or even marketing assets like the audiences you’ve built through email lists or social media accounts. In the meantime, you should also pay attention to taking security measures when it comes to emails by checking the latest phishing statistics or consulting with a professional for the best performance.
Work out future profitability
Buyers want to know how much they’ll make if they purchase your business.
To figure that out, you can calculate net profit over the past few years and then account for the future revenue with income and industry growth multiples.
For example, you could calculate the average income growth over the past two years (or whatever time frame you think would be most representative), then apply that multiple to your future growth. That could be 50% growth, for example.
Then you apply the industry growth multiple used by businesses in your space. That might be another 50% growth.
At a high level you could estimate that your profits have the potential to grow 100% over the next year.
This can be a quick and easy process for small businesses with well-documented finances, however it leaves gaps. What are the costs associated with growing more? Is the current industry multiplier a good indication of future market conditions?
Getting to the bottom of these questions might be a combined effort of appraisers, accountants, analysts and your leadership team.
Calculate your business’s value
Now let's look at the calculations involved in coming to your business’s valuation.
Here’s a very simple version of the sums involved. First, estimate net income by subtracting your expenses from your gross profits.
Gross Profits - Expenses = Net Income
Then, determining your multiple involves doing some research and a little guesswork. To start, you’ll want to consider the size of your business, your financial history, and the multiples similar companies have sold for.
For example, if a similar business in your industry, of your same size and risk, sold for a multiple of 3, you could estimate to sell for a multiple of 3 or above depending on your potential for growth.
Net Profit x Multiple = Current valuation
Next, adjust for growth using your own historical growth and the growth of your market. You’ll want to consider if your market is stable or growing, and how that will impact the growth opportunity for your business.
Compare your growth rate to the market to see exactly how your business compares to others in the industry. Lastly, add growth projections by applying your growth rate to yearly net profits.
If you have historically grown by 10% and the industry has matched that growth rate you can use that to help determine future growth and profitability.
Net profit + Growth Percentage = Following years net profit
Year 1 is $125,000
Year 2 is $125,000 + 10% = $137,000
Year 3 is $137,000 + 10% = $150,700
Year 4 is $150,700 + 10% = $165,770
Now add each year's profit together and you’ll have an estimate of your business value.
$125,000 + $137,000 + $150,700 + $165,770 = $578,470 (Business value based on 4 years)
Check your market valuation
Ultimately, your business is only worth what the market will accept. Listen to what investors and buyers are saying about your valuation and business worth, if their points are valid, you may need to make adjustments.
As we’ve already said - although this article is helpful to your business valuation, it’s no substitute for speaking to professionals who can take the time to understand your business’ specific situation.
Small business valuation methods
You can calculate the value of your business using four different valuation methods and compare your results to get the most accurate calculation.
Adjusted net asset valuation method
This method uses both your tangible assets and intangible assets to estimate the value of your business. This includes equipment, property, inventory, patents, copyrights, and more.
The adjusted net asset method calculates the difference between the current market value of your assets and liabilities. To get started with this method, list your assets and their current value. For more accurate results, estimate how much your depreciated assets would sell for right now.
This works best for businesses with a lot of assets and not a lot of revenue. Assets can be physical or intellectual property. It can also help you keep track of spending even if you're not looking to sell yet.
Two revenue-based valuation methods
With these two methods, your business value is determined by estimating the income your business will generate in the future.
Capitalization of earnings method
This first income method uses your cash flow, ROI, and expected future value to calculate the value of your business. Bear in mind this method doesn’t account for fluctuations in business performance so it’s best used for established businesses with steady profits.
Discounted cash flow method
This method determines the present value of your future cash flow. You can calculate your business's cash flow forecast and adjust it based on the risk involved to sell your business. Since this method accounts for future fluctuations in performance, it's best for startups or businesses with rapid growth or who have predictable cash flows.
Market-based valuation method
This last method determines the value of your business based on your net income and sales of similar businesses in your industry, giving you a realistic value for the market.
Multiply net profit by the most fitting multiple for your company. You’ll assign a multiple to your small business from 2-10, depending on the risk and size of your business. Then you must account for profit growth or loss over the coming years, and take a look at historical profits or competitors to align your value with the current market.
This method is great for any business, especially those growing quickly, but you’ll need access to industry information on comps in your market. To get this information, you may need to hire an appraiser who will have access to market databases and other information unavailable to the public.
How to write your business financing plan
Your growth plans and the makeup of your business will determine the valuation method you choose. Having a financial business plan will help you assess opportunities and opportunity costs as you scale and grow - but, more importantly, the valuation process will give you a good idea of your business’ strengths and weaknesses.
Here is how you can get started on a business financing plan of your own:
Review strategic plan
Identify how you plan to grow and generate profits. If you don't have one already, establish a reliable business model you can use to help plan for the future. Create realistic goals and expectations for what you need to grow and plan your steps ahead using OKRs. Start thinking towards the future, will you need more employees, work space, or funding? If so, when will you need it?
Develop financial projections
Financial projections help manage some of the uncertainty of the future by giving us something to expect. You can use financial projections to determine how much profit you’re generating, and how much you’ll continue to generate in the future. This information is extremely useful for planning rounds of funding. Financial projections help you determine the best times to raise capital and just how much you’ll need.
If you have good credit and steady revenue you may be able to find an affordable unsecured loan from a bank or credit union. If you have poor credit, or haven't been in business for long, you still may be able to find secured or cash flow loans but you’ll likely pay a lot in interest and fees.
How to improve the value of your small business as a business owner
The shortest, most obvious answer to this question is to build an incredible business.
Of course, that takes time. But the process of getting a business valuation can itself help you focus on what you need to do to make your business more profitable.
For example, by working with an appraiser you can put together a range of valuations that vary based on different outcomes. So you can model more revenue per customer, fewer customers, higher churn (for example).
This helps you understand where you should focus your efforts. Is it customer acquisition? Retention? Pricing? All of these dials have an impact on your valuation.
Now you’re familiar with the process for valuing small businesses, decide who you need to hire and which methodologies would work best for you.
No matter what plans you have for your business, calculate your business’s valuation regularly. Having an accurate and up-to-date business valuation will prepare you for opportunities and help you prepare for obstacles.