Business Valuation Blog | Understanding Buying / Selling a Company

When you're reviewing a business's overall financial health, one term that is often tossed around is valuation multiples. If you are unfamiliar with this variable measurement, it can seem like a complex concept, therefore, we will attempt to break it down in a more simplistic way. Here's a brief overview of what valuation multiples are, how they're calculated and how they can impact a company's overall value.

What are valuation multiples?

A valuation multiple represents a figure that is applied to a company’s overall income or revenue based on the industry and market they are in, as well as a projection of the reasonableness of long-term earnings. The estimated figure by which the income is “multiplied” is deemed the valuation multiple. Depending on the business involved, this multiple can be anywhere from a 1x to 50x multiple on a broad scale basis.

How is the valuation multiple estimated?

Multiples represent a certain expected amount of income per year. If a company is measured at a multiple of 3x, it means that a buyer is willing to pay the equivalent of three times the expected annual income to the seller. At this multiple, the company's income is estimated to pay back the investor over the course of three years, assuming it continues to perform as expected based on historical practice. A multiple of 5x means the company is valued at five times the projected annual income and that a buyer will see the investment returned over a five-year period. However, if a company is actively growing, much higher multiples may be utilized, based in part on the reasonableness that the business has a long-term ability to continue to generate steady or growing revenue.

How do valuation multiples help measure your company's worth?

What impact can these valuation multiples have on your specific company's financial health? To use an example, a startup tech company may have revenue of $50,000 in its first full year of operation with an increase to $200,000 in the second year. If it's purchased at this point, where should the multiple fall? If it's projected to quickly grow to $5-10 million in revenue annually, say within five years, paying a multiple in the range of 20x-40x annually may be considered acceptable. This is not atypical for startups with rapid growth potential.

More commonly, however, in businesses with historic, longer-term steady levels of revenue in the small to a mid-size market sector, you will see valuation multiples between 1x-10x based on a number of factors, including diversification, contractual relationships, competition, intellectual property (ex: patents, domain names, trademarks), and the industry or market involved.

In summary, if you are interested in understanding the valuation multiples of a particular business, you should engage a certified business valuation professional who utilizes standardized methodologies to measure this variable as part of a larger appraisal effort. By understanding how valuation multiples are calculated, you're in a better position to improve those numbers and pay or receive a fair price for your company, whether it's for a business loan, company sale, or purchase.

Knowing the current value of your business can provide you with ideas to improve areas that may need help, while further capitalizing on areas of strength, to continue to operate a successful company. By working with a certified business appraiser, you are ensuring that the valuation multiples and other factors you work with are current and accurate in relation to your company's overall value.

Seller's Discretionary Earnings (SDE) is a type of income measurement that is calculated when a business is changing hands. SDE is a specific calculation involving earnings before interest, taxes, depreciation, and amortization (EBITDA), which was discussed in our last blog post, as well as other factors that impact a company's value as you engage in a buy/sell transaction. Here's a look into SDE and how it measures the value of a company

SDE is a useful tool from both the buyer and seller’s perspectives. If you're on the purchase or acquisition side, the seller's discretionary earnings will provide you with the information needed to develop a reasonable estimate of your expected return on investment (ROI), as well as obtaining an understanding of realistic expectations going forward for the business. From the seller’s viewpoint, this measurement allows you to support a high level of overall value during sale negotiations. Understanding SDE allows you to make informed decisions while preparing to buy or sell.

As noted earlier, SDE utilizes EBITDA and considers the owner's overall value to the company and the benefit they derive from the business, above any salary paid. Here is what is typically considered when measuring the owner's overall value, compensation, and benefit:

• Value estimate of the owner(s) overall contribution to the business: The owner’s value to the business is a combination of the revenue that can be directly tied to a specific owner, as well as the value derived from their day-to-day operation of the business. This is especially important when a share of a business or partnership is being sold with multiple owners. When owners actively participate in operating the business, this measurement requires that historic, current, and projected benefits be calculated to determine the value of the selling owner's sales efforts and overall labor in the company.
• One-time expenses: Owners benefits from the business include any number of expenses that are charged to the company and will cover a wide range of one-off or annual purchases, including items such as website design services, home office leasehold improvements, licenses, certifications, application fees, organization memberships, as well as any number of similar expenses to the company.
• Home office and business expenses reimbursed or charged to the company: These would include reimbursable monthly costs for the owner’s home offices, including rent, utilities, healthcare, life insurance, transportation, certain travel & living expenses, and related items.

With an understanding of how SDE and the owner’s overall contribution to the business are measured, you can gain a better understanding of your company’s overall financial health and how it is viewed in the industry. Seeking a more detailed independent measurement of value for your company, especially if you plan to sell, expand or refinance debt is always a sound idea. A certified business appraiser will provide you with the overall value of your company, as well as information on the market, industry, competition, and the strengths and weaknesses of your company.

When you're trying to determine the financial condition of your business, there is a wide range of formulas and techniques available. One key measurement is calculating earnings before interest, taxes, depreciation, and amortization (EBITDA). What exactly is EBITDA? Here's an inside look at how this figure is calculated and utilized in measuring the financial status of a business:

A Breakdown of EBITDA

The components of EBITDA consist of:

• Earnings: This refers to net profit, or the total revenue of your company less expenses and overhead.
• Before: The earnings before additional deductions are considered.
• Interest: Interest represents the cost of any loans and similar financial instruments your business has on the books.
• Taxes: This typically refers to income taxes only.
• Depreciation: Depreciation represents how much capitalized value you deduct for your fixed assets over a particular time period. It is typically determined using acceptable accounting standards such as the Modified Accelerated Cost Recovery System (MACRS) or through an updated valuation of your company’s tangible property (equipment and real estate).
• Amortization: Amortization is the reduction of business debt, such as loans and alternate types of financing over a given period.

As a general rule, EBITDA is a measurement to determine a company's profitability, or cash flow, however, it may not fully represent cash earnings. EBITDA considers a wide range of factors that come into play with business finances. It is not a universally accepted accounting measurement, and, therefore, has some flexibility with how it is calculated and measured.

From an application perspective, it is used by banks and financial services companies to estimate debt servicing levels. It is also commonly used to compare similar businesses within an industry or market and as a tool to preliminarily estimate a company’s current value using multiples of EBITDA.

A similar calculation that provides the same basic information is the earnings before income and taxes, or EBIT. The difference with this measurement is the exclusion of depreciation and amortization. When these variables are removed from the calculation, it represents the company's operating profit vs. overall cash flow.

With an understanding of how EBITDA is measured and utilized, you can gain a better understanding of how your company is viewed in the industry and its overall financial health. It is always optimal to have a more detailed independent measurement of value completed for your company, especially if you plan to sell, expand or refinance debt. A certified business appraisal will provide you with the overall value of your company, as well as information on the market, industry, competition, and the strengths and weaknesses of your company.

There are different ways to perform business appraisals. Whether you're hoping to buy an established company and get into business for yourself or sell your company for a fair price, it's important to know the different approaches to valuing your business and which one is the most appropriate for your situation.

Pros and Cons of Market-Based Business Valuations

A market-based business appraisal makes sense for many industries. Consider the owner of a semiconductor manufacturer located in California who wants to sell the company and retire. If there are other businesses nearby, operating in the same or similar marketplace, a business appraiser can compare the subject business being sold with others like it, getting an idea of the market share and competitive advantage of the business.

A “Gross Revenue Multiple Method” may work in these cases. Under this method, the appraiser takes the transaction price and divides it by the revenue. They then find similar companies and determine a gross revenue multiple. This multiple is applied to the target company's revenue to roughly estimate a business value. This method is simple and quick, however, far less detailed than other appraisal methods, and often best for preliminary measurement purposes only.

Pros and Cons of Asset-Based Business Valuations

An asset approach estimates how much it would cost to build a similar business from scratch. In this type of valuation, the professional appraiser will estimate the total assets and liabilities of the business. Subtracting liabilities from assets, the appraiser will come up with a valuation.

This method works well for companies that have significant physical assets. However, companies that have intangible assets find that an asset-based method may not accurately reflect their worth. Consider the example of an innovative engineering firm. The imaginative engineers who come up with elegant solutions to problems are not captured as “added-value” in an asset-based approach. If the engineering company was sold to a new buyer, but the existing staff quit, much of the company's true value would be irretrievably lost.

Pros and Cons of Income-Based Business Valuations (The “Discounted Cash Flow” Method)

If your company has a stable earnings flow, then the “EBITDA”, (earnings before interest, taxes, depreciation, and amortization) can portray an accurate business valuation. Since this provides a snapshot of the business valuation at one point in time, it might not be the best method if earnings are projected to spike or if the company is experiencing a slow quarter.

If the business is going through an inconsistent period, the discounted cash flow method may work well. Here, the appraiser estimates the future benefits of the company, then converts them to present value to come up with a fair market value.

Ultimately, a certified, experienced appraiser can determine which method makes sense for any given company at a given point in time, and reasonably estimate the company’s value, while explaining the process to key investors and owners. Given all that is at stake when considering selling your business, it's critical to hire a certified business appraiser who understands your industry.

When you need to have a business valuation performed, a reputable valuation firm can provide you with significant insights into your company that in turn, can offer a wide range of benefits to your business. But what exactly happens when you're working with a valuation firm? What can you expect from a certified business appraiser? Here's a quick look at what takes place when undergoing a business valuation

To start with, a quality business valuation company will look at much more than just the basics of your business and its financial health. They will complete a comprehensive review of the industry and what factors may affect your business's ability to perform in the marketplace. They'll take a solid look at the risks and rewards of certain growth plans and provide you with a detailed report of what your business is worth along with areas in which it is strong and in those which could be improved.

Here are the typical steps that are taken in the process:

1. The appraiser will gather basic information about your business. This will include the type of business, availability of key information, potential areas of importance to the business valuation. The purpose of the valuation is also determined, as particular types of appraisals are required for different situations.
2. The business valuation appraiser will then provide a proposal including the timeframe expected for the appraisal report and the cost expected. They will also request all internal documentation for the valuation, including financial data, asset information, and data on specific areas that may be unique to your business.
3. Next, they will take a look at what aspect of the industry your business falls into and what portion of the market share it holds, while examining key areas including finances, overhead costs, regularity of income, the actual market value of assets, and related documents. Intangible factors such as your reputation in the community, the desirability of the business location, and unique facets of the business will also be taken into account.
4. Using all of this information, the certified appraiser will develop their analysis and issue the formal report. This report utilizes standardized, accepted methodologies and is designed to stand up to scrutiny that will hold up in insurance, tax, and legal circles.
5. Once the report is issued, it will be reviewed with you to ensure it is an accurate reflection of your business and potentially make adjustments for any new details not taken into account.

By better understanding the process, as summarized above, you can better prepare and know what to expect when a business appraiser begins working with your firm. If you're not currently working with a certified business appraiser who has experience in your industry, please contact us and we will get things started for you.

When your business is within the retail sector, consumer confidence and market uncertainty can make all the difference in whether you are operating in the red or the black. But how do you adapt to changes in the market? One option to consider is a business valuation today so you can plan for the future, focus on your strengths and avoid the potential pitfalls of this industry. You can then adapt to changing market conditions and position your business to take advantage of the high points in the market while riding out the low ones.

Many people only consider obtaining a third-party business valuation when they are looking to buy or sell. The benefits gained during a retail store valuation now, regardless of your future plans, can provide you with valuable insights into your operation, and a better understanding of your overall assets and liabilities. This, in turn, gives you the tools you need to get your business through the difficult times while taking advantage of growth opportunities in the good times.

As an example, regardless of the timing, it is likely that your business has recently squeaked through an economic downturn as well as seasonal upswings in sales. Based on your experience, you would now like to consider growing your business by adding a new location or merging with a competitor that hasn't fared as well. In preparing to manage the due diligence process, you need to know what your business is worth, whether it's to secure the financing and investment you need, or to know where you stand in comparison to competitors. By learning this information, you can better negotiate the terms involved in the potential transaction.

The certified independent appraisal report you receive should have all information you need including a report on your market sector as a whole and its anticipated growth or loss in the upcoming years. A look at your competitors should also be included, detailing how they compare to you in the market. Your assets and liabilities are reviewed, giving you valuable insights into the areas you may need to upgrade or replace that are inefficient or even failing.

As a result, you may see innovative approaches to customer support that strengthens your business' overall stance in the market sector. The appraisal may even help you look at your online presence and level of digitization, as well as how that capability is expected to allow your business to expand into new markets.

In summary, you'll have the supporting documentation you need to get that loan for a new location opening or to improve and expand your existing business processes. You can make smart, informed decisions on what needs to change in your company to boost its performance and see where you should continue to invest for future growth. Obtaining a retail business appraisal from a certified experienced valuation firm is one of the best ways to gain these insights into your company which, in turn, will provide options that allow you to adapt to meet changing market demands.

When you've worked hard to position your business for expansion, it's difficult dealing with the likelihood that not everyone sees the potential growth right now, when you most need them to. If you need to get more today for your business' future plans, you need partners who can help you obtain everything you can in today’s market.

Valuing a rapidly growing company is a challenge, but well worth the effort when it's time to consider a new investment, or possibly merging with another operation. The same can be said for those looking to invest in or even purchase the business.

There are several reasons you see the potential for rapid growth in your company. New market expansion, increased product and service demand, higher commodity prices, and changes in your operating efficiencies are just a few. Whatever the reason, your company is growing, and you want to take advantage now. Where do you go to make that happen?

A common, less effective way is to simply discount the value of that growth over a short-term, fixed future period, ultimately dictating a lower than expected business value thus, receiving less consideration than you should. On the flip side, you may overestimate the growth rate, and over-leverage your position as the value is not supported by realistic growth expectations.

The best option is to hire an experienced, certified appraiser to perform a company valuation. One who has experience in your industry and with growing markets in general. But what does that appraiser base the company's value on? Here are a few areas they typically consider:

• Future Earnings: How much is the business forecast to earn over the next several years? If it's realistically and materially higher than in the past, it will be taken into consideration when determining current business value.
• Market Conditions: Is the market booming, with many businesses within that sector seeing strong returns? If so, how long is this trend expected to continue? Much like the housing bubble and the dot-com crash, trends may change, though strong companies that are well managed through may expect to see a stronger market share in future upswings.
• Innovation in the Industry: Is your business viewed as a leader in innovation or does it create the same basic products and services as every other company across the industry? If you have a history of innovation, it can be reasonably expected that your growing company will continue to see strong growth, supporting a higher value.
• Goodwill and Reputation: Does your business have a reputation for excellence in the industry? A strong reputation can make a huge difference between reliance on one-off sales or loyal, committed customers who come back for your services and products time and again.

The work you've put into your business to prepare for expansion and take advantage of opportunities as they've arisen deserves to be recognized and rewarded, and valuing a growing company is a great way to substantiate that effort. A certified business appraisal conducted by an experienced valuation professional lets you take advantage of these future earnings, allowing you to benefit today from the forecasted plans.

Savvy business owners and executives know that obtaining independent updated valuations of their company is a vital part of maintaining a sound, overall financial picture. When your organization has branches all over the country, how do you ensure you're getting the same quality of service and reliability at all these locations if you are using a local appraisal firm? One solution is to consider using a national business valuation service, which provides your company with professional appraisers who have valued businesses in every state and understand the broader marketplace your businesses operate in.

How are these types of valuation firms different than local single location valuation companies? Let's find out:

What are National Business Valuation Services?

If your company has multiple locations, and an updated independent business appraisal is needed, it makes sense to have consistency in the quality of the work as well as the methodologies used to measure value. This ensures the firm providing the valuation is familiar with your industry across all regions of the country and can provide the same level of service while following consistent guidelines and procedures for all of your operations.

A national business valuation firm will assign one project manager to handle the entire workload, so you only have to communicate with a single person throughout the process. Their job is to handle the day-to-day details of obtaining the documentation needed from your business as well as managing any other appraisers involved in the valuation effort. This beats the alternative of potentially having to work with multiple companies or individuals while taking a chance that a local appraiser might not be qualified to manage a much larger project.

The end result is a reliable, supportable valuation completed by certified, experienced appraisers with a consistent methodology that provides your company with the information needed to understand your current and future needs as you evolve into the next stages of your business plan.

Business Valuation Specialists LLC is a national business valuation firm that has been providing appraisal services across the country since 2003. Our highly-trained, qualified appraisers are Certified Valuation Analysts (CVAs) through the National Association of Certified Valuators and Analysts. We are available anytime to help answer questions you may have about getting a quality business appraisal performed on your company.

When you seek financing to purchase a business, it is typical that potential lenders will require an independent valuation to ensure the deal is sound. They want to confirm the sale price is reasonable and the business itself is financially viable, to mitigate the risks involved with the investment. Learn what it means to work with a reputable valuation firm to better understand this important part of the loan approval process.

Is a Valuation Required for a Business Loan?

Many lenders require that you have a company valuation performed by an appraiser. If your loan is backed by the Small Business Administration (SBA) or a similar government-backed program, they will often require an appraisal. SBA loans cannot exceed the appraised value of the business, inclusive of any real estate or equipment assets being acquired as part of the sale. Private bank lenders will have similar guidelines for business appraisals for financing approval.

As the buyer seeking the loan you should have additional money-raising plans in place, should the appraisal come in lower than the purchase price of the business. You can decide to raise the funds through private equity, use personal capital to make up the difference, or even go back to the seller and renegotiate the sale.

Ultimately, the appraisal protects your interests as a buyer, as well as the bank's interests as a lender. It may not make financial sense to purchase the business at a premium above what it’s worth unless you have ulterior reasons for doing so. For example, in a seller’s market, where there were other bidders involved in the sale process, or if you needed to acquire the business as part of a growth plan. Either way, it is better to understand the true market value of the business and have all financing options in place before you close the deal.

What Happens During the Business Appraisal Process?

The bank may select their own valuation firm to do the appraisal or have you select someone. In both cases, ensure the appraiser is certified, with sufficient training, knowledge, and experience to adequately complete the valuation. The appraiser will perform independent research on the business and review your documentation to estimate the worth of the company. They will rely on commonly used methodologies, such as the asset, income, and market approaches.

As the buyer, you will need to facilitate the process of working with the seller, lender, and appraiser to ensure the documentation needed is available and accurate based on your prior due diligence review. It is in the seller's interests that the appraisal meet their price too since they want the deal to close.

Once the valuation is completed, a report will be prepared and submitted to the lender, who will distribute the report to the appropriate parties. As a buyer, you should review the report to better understand the valuation of the business and its associated goodwill and tangible assets. You may also want to consider using the report to assist in insurance, tax, and accounting purposes.

In summary, you can rest assured that if an appraisal requirement coincides with you obtaining the best financing option for your new company, Business Valuation Specialists LLC will be there to guide you through the process efficiently and effectively.

When you're selling a business to a third party, the topic of appraisals may arise. But why is it important when you're selling your company, and what difference will it make at the end of the day? A formal valuation of your company is one of the key components that drive the transaction. Here's why:

Why Business Valuation is Important When Selling a Business to a Third Party

When you're planning to sell a business to someone you don't know, you want to make sure everything is done fairly and equitably. Completing an independent, certified, third party appraisal early on is the first step to ensuring this happens. By having an appraisal performed, you can see where your business needs improvement, and learn where it is already strong so that you don't have to put further effort into areas that are already in great shape. Once you've made changes and improvements in those areas that required them, your business should increase in value, allowing you to realize the benefit from your actions and detail these updates to potential buyers.

If you're like many business owners, you know that your company should be worth more than the assets on the balance sheet, but may not know exactly how much more. By having a certified business appraisal in hand, you have a better idea of what that figure should be, and can consider offers that are reasonable while dismissing those which are not. You can also decide if you want to ask a price that is in line with similar businesses in your market or if you feel you have a unique position that should be accounted for, ask something higher for that consideration.

Having a formal business valuation helps you at the negotiating table. Because a certified appraisal is based on accepted standardized methodologies, it represents best appraisal practices and procedures, and can also be useful in legal, insurance, and financial circles. If you want the potential buyer to come up in price, providing them with a copy of the appraisal report may make them aware of facts and circumstances about your business they may have previously been unaware of. This gives them a legitimate supportable reason to either change their initial offer or meet a counteroffer you've proposed to them during negotiations.

Business appraisals are vital to your success when selling a business to a third party. If you're getting ready to sell your business and haven't contacted a business valuation firm, please feel free to contact us today. Our qualified business appraisal specialists are ready to help you get the maximum benefit from your business sale.