Business Valuation Blog | Understanding Buying / Selling a Company

What appraisal methods are best for valuing a small business?

Posted by Business Valuation Specialists LLC on Jun 28, 2017 11:33:00 AM


You've worked hard to grow your small business, and now you want to sell it and reap the rewards. To do this, you'll need a business valuation expert who understands the best ways to value a small business like yours. When it comes to valuing a small business, some appraisal methods work better than others. Get our recommendations to understand your best options for obtaining a fair market valuation in anticipation of selling your company. 

Which Appraisal Methods to Use When Valuing a Small Business

These methods provide accurate, timely valuations for small businesses. They are flexible, fair, and easy to understand: 

  • Earnings multiplier method - This income-based valuation method works well for robust small businesses that will be sold on the open market. In this approach, the small business appraiser takes a multiple of the company's earnings potential, which can then be used to determine a business value or asking price. This approach is transparent, tangible, and easy for both buyers and sellers to grasp.
  • Discounted cash flow - This method often makes sense when small businesses experience inconsistent earnings over time. If your small firm oscillates between peak years and lean years, a discounted cash flow appraisal can help even things out, thus capturing a fair value. In this method, all future earnings are translated into present value to determine a small business valuation. 
  • Market-based - A small business in a unique or growing industry can benefit from a market-based evaluation. This is frequently true when an industry has under performed in the past, but is revitalizing or enjoys a promising forecast for the future. In this situation, past earnings may not reflect the accurate future earnings potential of the business. By contextualizing the small business value in market terms and comparing the company to comparable firms that have sold recently, a business appraiser can accurately capture the business's fair market value for buyers and sellers alike. 

Which Appraisal Methods to Avoid When Valuing a Small Business

It is generally ill advised for small businesses to use the following business valuation method: 

  • Asset-based valuation - While an asset-based valuation may seem like an effective way to measure a small business's worth, it is rarely recommended. This process can oversimplify things. One exception to this rule is for liquidation purposes. If your business is closing, or if you are filing for bankruptcy, an asset-based valuation may be the right choice.

While there are exceptions to every rule, ask your appraiser to explain why they would recommend moving forward with this approach. In general, an appraiser should be able to sit down with you before the appraisal, explain the process, and answer any questions you have about what to expect from the process. A good appraiser wants to provide you with useful and unbiased information that will help you with your next steps. 

To create the most leverage for yourself, start planning your small business appraisal at least a year before you want to sell the company. This way, you'll be able to make smart decisions in planning for the sale, envisioning your future, and leaving the company you've worked so hard to build in good hands. 

Topics: valuing a small business