You could use all three of these techniques in less than 30 minsIn this article, I’m going to show you three ways of doing a rough-and-ready small business valuation. If you wanted, you could do all three of the techniques in less than 30 minutes.
Of course, the techniques below will only give you an estimate of how much your business might sell for – not accurate enough for official purposes (legal, tax, etc.) – but they are an excellent way to get a rough idea of the value of the business you are creating.
I’ve specifically chosen to describe the three techniques below because they’re the easiest to apply quickly to get a rough estimate. However, if you engage a professional firm to give you an official valuation of your business they may use other techniques.
Warning: the smaller and newer your business is, the less accurate these techniques will be. Also, you can’t get a truly accurate idea of the value of your business without talking to an expert.
My advice is that if you don’t have any staff or you’ve been running your business for less than two years, don’t bother trying to value your business yet. Instead, you should use the proven techniques within the Small Business Multiplier programme to rapidly grow your business, and think about estimating the value when it is more established.
Contents (click to jump to section)Method number 1 – small business valuation using a multiple of earnings
Method number 2 – small business valuation using a market approach
Method number 3 – small business valuation using entry cost Maximising your business value
Method number 1 – small business valuation using a multiple of earningsThis is perhaps the most common way to estimate the value of a business and simply involves taking the profit for your business and multiplying it by a “scaling factor”.
First, work out your profit. This is the amount of money your business makes every year, before tax. Specifically, we need to take the adjusted net profit. The Adjusted net profit can be roughly calculated as the amount of money your business makes before tax, minus the cost that you would have to pay someone to run the business on your behalf.
To work out what that salary would be, you could go to a job site and search for “Head of [whatever it is you do]” or “Senior [your job]”. This is the “market rate” for the job you do.
It may be that you are paying yourself less than the market rate for the job you do – this is fine. However, bear in mind that the value of your business will be calculated assuming that the salary of the owner will be taken at the market rate. This is called an “arm’s length principle” – anyone who buys your business would want to know that they could keep it at arm’s length by letting someone else run it.
You may have noticed that your adjusted net profit (ANP) is zero or less than zero. In that case, your business is not worth anything according to this valuation method. If so, don’t panic! Get started with our online business growth course the Small Business Multiplier and we’ll help you to reduce your cost and maximise your income.
If you have an ANP of more than zero, the next step is easy. Simply multiply your ANP by 3 to get your first valuation.
So, if your business makes £80,000 profit in a year and you take a salary at the market rate of £50,000, your ANP is about £30,000. The rough value of your business by this method is
£30,000 x 3 = £90,000
Using 3 as a scaling factor is reasonable if
- The owner of the business runs the business
- The growth of the business is slow (or there is no growth)
You’ve now got your first (rough) valuation, so let’s see if it is similar to the estimate that you get from the next method!
Method number 2 – small business valuation using a market approachYou may find this technique even easier than method number 1. Also, it’s likely to be more accurate!
This technique is often the easiest and the most accurateThe idea of this method is to estimate how much your business is worth by looking at how much other, similar businesses are being sold for. This is a good method of estimating the value of your business because ultimately, any business is only worth what someone will pay for it! If you can see what people are paying for similar businesses, you’ll have a good idea of what yours could be worth.
Here’s how to do that:
- Find a directory of businesses for sale – a good example is http://uk.businessesforsale.com/
- Using the directory, perform a search for businesses like yours. For example, if you run a coffee shop: http://uk.businessesforsale.com/uk/search/coffee-shops-for-sale
- Find some examples of businesses that have listed both their net profit and their asking price. This will help you to work out a normal multiple of earnings to use for businesses in your industry, which you can use in a multiple of earnings valuation (as described above)
If you’re lucky, you may find a few businesses in the directory that are similar to yours. In that case, you can make a guess about what you could sell your business for, based on the asking price shown for those businesses.
That’s method number 2! Now on to the final method.
Method number 3 – small business valuation using entry costAnother way to do a small business valuation is to think about how much it would cost someone to start an identical business. For example, if you were running a business printing t-shirts, you would probably already have a printing machine, lots of ink and a lot of blank t-shirts. If someone wanted to start an identical business, they would need to buy all of that for themselves. They would also need to pay some designers to come up with good t-shirt designs and spend a fair amount of money setting up a new website and so on. To do a rough entry cost valuation:
- Write a list of everything you would need to set up your business if you were starting from scratch. You can include marketing costs (because it also costs money to get a list of customers)
- Estimate the cost of each of these things
- Add the costs together Be wary though – this valuation method will tend to over value a business. This is for two main reasons:
First, it’s often difficult to take potential cost savings into account. Could you run the same business using cheaper (or newer) technology? Could you set up the business in another location and save money that way? If so, then the entry cost should reflect that.
Second, an entry cost valuation is an optimistic valuation because it assumes that the people buying the business will be buying it as an alternative to setting up their own business from scratch. In fact, many people buy businesses and then take the business to pieces, selling off all the assets (the list of clients, the equipment, and so on). These assets are actually worth less when sold separately than when they are part of a working business.
This valuation might be a good way to estimate the value of your business if your profits are small but your business is stable – particularly if your business relies a lot on equipment or holding stocks (which add significantly to entry cost).
Maximising your business valueTo get a reasonable estimate of what your business is worth, try using all three of the methods described in this article and choosing a value that is somewhere between the different estimates.
Remember, it’s practically impossible to get a sensible idea of your business value without consulting an expert who can assess your particular situation. However, as I’ve shown, if all you need is a rough estimate you can easily come up with a number using a pencil on the back of an envelope.
Thinking about small business valuation is likely to make you wonder: what’s the most effective way to increase the value of my business, and how much could the value of my business if I did all the right things?
If you would be interested in taking part in a programme that could double or even triple the value of your business, I highly recommend you take a look at my online course for small business owners: The Small Business Multiplier.
In The Small Business Multiplier, we share some of the techniques used by the top 1% of businesses in the world and carefully show you how to apply them to your small business or professional practice. We expect all of our students to see dramatic results within 12 months.
The course is inexpensive, easy to follow, and includes a 1:1 consultation with me (Les Bailey). You can download an overview of the course for free and a monthly subscription will cost less than a daily cappuccino from a high street coffee shop.
Check it out today – I look forward to working with you.