How To Value A Business Based On Sales
Basic knowledge about how to assess the market value of your business is an essential skill for any business owner; applying for a loan, pitching to potential investors, and selling your business all require you to take stock of your businesses’ potential. Making a personal assessment of your business and clearly identifying your own wants and needs ahead of time is crucial for a healthy transition. Are you hoping to sell for as much cash as possible, or are you looking for an equity partner? No matter your preferences, this brief guide will walk you through the basics of business valuation.
How to Value your Business Based on Sales
There are many different approaches to valuing your business. Every business is different. There is no one-size-fits-all approach to selling. In fact, if you reach out to two different investment firms about buying your business, you’ll likely get back two completely different offers. Why? Because different firms rely on different valuation models to identify the financial health and growth potential of your business. Ultimately, the models that an investor uses depend on the type of business being sold, as well as the financial status of the business and the type of deal being made.
Profit Multiplier Model
How many years will an investor pay it forward? The profit multiplier model is perhaps one of the most straightforward ways of determining the value of your business. In this model, a company’s net profit is multiplied by a standard number—a profit multiplier. A standard multiplier for small businesses is usually three or four. This multiplier is then used to determine how long it will take for an investor to see a return on their investment. For example, if an investor pays $300,000 for a business that generates $100,000 in annual revenue, then the investor will see a full return within three years assuming the same rate of growth.
How much do similar businesses usually sell for? Before investing in your business, an investment firm will do due diligence in researching similar sales within your industry. A standard profit multiplier in one industry, for example, may be different from the standard used in another.
Discounted Cash Flow Method
Will you be receiving a one-time payment or payments over a set amount of time? The discounted cash flow method is particularly important when discussing a buyout that will roll out over a prolonged period of time. Why? The one-word answer: inflation.
The discounted cash-flow model is similar to the profit multiplier model, only this method incorporates inflation. Inflation is a decline in the purchasing power of money. For example, in 1908, a Ford Model-T cost $850. Now, adjusting for inflation, the same car would cost upwards of $22,000. The purchasing power of the dollar was stronger in 1908 compared to now. Future purchasing power is also something to consider when negotiating long-term buyouts with an investor.
Asset Valuation Method
Does your business have the potential to generate profit? This business valuation model looks at a business’s potential to generate profit, rather than looking solely at its current profit value. This model is used when a business has ownership over profit-generating assets, like technology, intellectual property, physical property, and equipment. Knowledge of the value of your assets is important for this type of valuation.
Essential Numbers A Buyout Firm Uses to Value Your Business
Valuing a business is a complex process. As we’ve shown above, several different methodologies can be used to evaluate what your business is actually worth. Yet, regardless of these different approaches, there are a few essential numbers that are important for any business owner to understand. Knowing how to calculate these basic statistics and understanding what they mean will help you engage in informed conversations with your buyout firm or potential investors.
1. Your EBITDA
How much are your net earnings? The first number to look at when valuing your business is your earnings before interest, taxes, depreciation, and amortization, which are collectively referred to as EBITDA. Your EBITDA provides a glimpse at your overall cash flow over a certain period of time. Here’s how to calculate your EBITDA:
- Formula for EBITDA: Earnings Before Tax + Interest + Depreciation + Amortization
2. Your Enterprise Value
How much is your business worth, right now? Your enterprise value is an essential number to share with potential investors or buyout firms. Your enterprise value is the current value of your business based on your current shares of stock, rather than cash earnings and income. Here’s a simple formula for calculating your enterprise value:
- Formula for Enterprise Value: (market capitalization + value of debt + minority interest + preferred shares) – (cash and cash equivalents)
3. A Multiple of your EBITDA
What is the general value of your business? A buyout firm typically is not solely interested in buying your business for its current annual total earnings—it’s the growth potential of the business and how its value compares to competitors that matter most. A firm will estimate the value of your business using a multiple of your EBITDA, which is a ratio of your enterprise value relative to your EBITDA.
The multiple will tell you how many times over your EBITDA your company is actually worth. For example, after some simple math, you may find that your business is worth 2.3x over your EBITDA, meaning that you should value your business at least that much.
Calculating a multiple of your EBITDA is simple—just divide your enterprise value by your EBITDA. Here’s what the formula looks like:
- Formula for Multiple of EBITDA: Enterprise Value / EBITDA
4. Percentage Growth in Revenue
How much has your company grown, year after year? A buyout firm will want to evaluate how your business has grown over time—by what rate has revenue increased? Growth in revenue is calculated as a simple percentage, comparing one year’s growth to another. Here’s the formula:
- Formula for Revenue Growth: (Current Period Revenue - Prior Period revenue) / Prior period revenue
5. EBITDA Margin
How much cash profit can you expect from your business? All of the statistics listed in this article are used to evaluate whether or not your business is a safe and reliable investment. But, when determining financial health, the EBITDA margin is one of the most important.
The EBITDA margin compares your business’s net earnings as a percentage of your business’s total revenue. This number helps a buyout firm evaluate the cash profit of your enterprise. Here’s the simple calculation:
- Formula for EBITDA Margin: (earnings before interest and tax + depreciation + amortization) / total revenue
6. The Value of your Assets
How much does your business currently own outright? Before sale, it’s vital to take an accurate inventory of the value of your current assets. Assets include all property that you own outright, be that property, equipment, or other technology. The value of intellectual property will be determined by its earning potential. The saleable value of assets is determined by subtracting the debt still owed on the said assets.
- Formula for Asset Value: Market value of owned assets - debt owed on said assets
7. Price to Earnings Ratio
How much should an investor put forward for your business? This is usually calculated with a price-to-earnings ratio, often written as the P/E Ratio. This statistic compares the price at which the business is sold to the business’s actual earnings. Investors will often use the P/E ratio with a profit multiplier (discussed above) to help determine the number of years before they will make a return on investment.
- Formula for P/E Ratio: Value of business / profit that the business generates
8. Percent Value
When selling your business, will payments be affected by inflation over time? The percent value (PV) formula calculates today’s value of money that you will collect in the future. For example, if you were given $100 each year for 10 years and assumed a five percent annual inflation rate, by the 10th year, your $100 would only have $61 worth of purchasing power.
9. Percent Ownership
How much of your business is the buyout firm actually buying? This is perhaps one of the most complex parts of selling your business. Will the firm be purchasing 60 percent of your business, or all of it? Will the firm pay out the entire value of the business, leaving you to “buy back” your stake on the same terms? Coming to a clear numerical agreement between all stakeholders is essential for determining how much equity you will have in your business after the sale.
10. Amount of Leverage
Will a firm have to take on debt to buy your business? If so, the firm will need to carefully evaluate whether or not the debt to cash flow ratio is a safe investment. If the firm needs to take on a sizeable amount of debt to purchase a business with a variable growth rate, then the firm risks losing money on the deal. A firm will always evaluate the amount of leverage needed to finance the purchase of your business before making an offer.
Get A Free Valuation Today
Thinking of selling? We can help. Moonshot Brands buys e-commerce brands and grows them long-term. Moonshot Brands values founder contributions, offering them fast and lucrative exits. Moonshot also allows founders to share in the long-term growth of the brands they built via equity, earn-outs, or other upsides. Many sellers have the opportunity to continue to grow their brand inside the Moonshot solar system with access to resources, growth capital, and the greatest minds in marketing, supply-chain management, operations, and more.
Contact Moonshot Brands today for an official valuation. We’ll get back to you in 48 hours, make an offer within weeks, and close the deal within 45 days.