Business Valuation Basics: How Much Is a Business Worth?
Knowing what a business is worth matters long before you sell it. Owners need valuations to plan an exit, bring in a partner, secure financing, settle a divorce, plan an estate or resolve a dispute. A good valuation also shows what drives value, so you can improve it.
Key takeaways
- A business valuation estimates what a company is worth, usually its "fair market value."
- Appraisers use three approaches: income, market and asset-based.
- Small businesses are often valued as a multiple of seller's discretionary earnings (SDE) or EBITDA.
- For sales, lending, taxes, divorce or litigation, you need an independent valuation by a credentialed professional.
Valuation at a glance
When do you need a business valuation?
Selling or buying a business, or a share of one
Buy-sell agreements between partners
SBA loans for business acquisitions or changes of ownership
Estate and gift tax planning, or transfers to family members
Divorce settlements
Shareholder disputes and other litigation
Employee stock ownership plans (ESOPs) and stock options
Financial reporting, including purchase price allocation and impairment testing
Restructuring and solvency analysis
The three approaches to valuation
1. Income approach
Values the business based on the cash it is expected to generate in the future. Common methods are the discounted cash flow (DCF) method, which projects future cash flows and discounts them to today’s value, and the capitalization of earnings method, which divides a normalized level of earnings by a capitalization rate. This approach suits profitable, established businesses.
2. Market approach
Values the business by comparing it with similar businesses that have sold, or with similar public companies. The result is often expressed as a multiple, for example three times earnings or one times revenue.
3. Asset-based approach
Values the business based on the fair market value of its assets minus its liabilities. This is most useful for holding companies, asset-heavy businesses or companies that are not profitable.
Professional appraisers usually consider all three approaches and explain which ones they relied on and why.
SDE and EBITDA multiples
SDE
Seller’s discretionary earnings (SDE) is the total financial benefit to one owner-operator: pre-tax profit plus the owner’s salary and perks, interest, depreciation, amortization and one-time expenses. It is used mostly for smaller, owner-run businesses.
EBITDA
EBITDA (earnings before interest, taxes, depreciation and amortization) is used for larger businesses with professional management.
Multiples vary widely by industry, size, growth and risk. Smaller businesses typically sell for lower multiples than larger ones, because they carry more risk.
What drives a higher value
- Consistent, growing and well-documented earnings
- Recurring revenue and a diverse customer base, with no single customer dominating
- A business that runs without depending on the owner day to day
- Strong management team and documented systems
- Clean financial statements, ideally reviewed or audited
- Defensible market position, contracts and intellectual property
Choosing a business appraiser
Look for professionals with recognized credentials, such as ABV (Accredited in Business Valuation), CVA (Certified Valuation Analyst), ASA (Accredited Senior Appraiser) or CBA (Certified Business Appraiser), and experience in your industry.
An independent valuation that holds up under scrutiny from buyers, lenders, the IRS or a court is worth far more than an online estimate.
Need a business valuation?
Foxboro Consulting Group's credentialed appraisers have prepared hundreds of business valuations for sales, M&A, financing, estate planning and litigation.
