6 FAQ Answered: How to Value a Business

Brad Nakase, Attorney

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For ten years, Anthony has been the owner of an artificial intelligence company based in Santa Monica. The company has enjoyed a lot of success, and now Anthony is ready to consider his next project. He has heard of similar businesses receiving generous offers from buyers, and he is prepared to sell his company to the highest bidder. However, Anthony is not sure how best to value his business. He is afraid that he might undervalue the business, undermining all the hard work he did over the years. He also does not want to overvalue the business and not receive an offer as a result. Anthony wants to come up with an appropriate value that fits the industry he is in and do right by his company. He begins to research how best to value his business so that he can get a fair sale.

1. How Does a Business Owner Determine a Business’ Market Value?

After years of hard work, at some point, a business owner may decide it is time to sell his or her beloved business. Perhaps the owner wishes to use the proceeds of the sale to finance their retirement or move on to the next big project. However, in order to sell a business, an owner first needs to determine the value of the company. Understandably, in the course of making such a big move, this decision may be worrying. How does one figure out the market value of a business? Certainly, an owner does not want to undervalue all their hard work. At the same time, an owner will want to make sure that the business finds a buyer. Luckily, there are several ways to determine the market value of a business.

2. How Does an Owner Tally the Value of Assets?

One of the ways to value a business is to tally the value of assets. To do this, a business owner should add up the value of everything the business owns. This would include all equipment and inventory. Debts and liabilities should be subtracted from this amount. To find a starting point, a business owner should look at the business’ balance sheet. However, a business is likely worth much more than its total assets. A business owner can make the argument that revenue and earnings add to the business’ value.

3. Can a Business Owner Base the Value of a Business on Revenue?

Another way to value a business is to base the value on revenue. To do this, a business owner should look at how much the company earns in annual sales. Once an owner calculates this amount, he or she should go to a stockbroker or business broker to determine how much a typical business in the industry would be worth based on that level of sales. For instance, a business in a particular industry with a certain level of sales might sell for two times the annual sales. So, a business that makes $300,000 in revenue each year would be worth approximately $600,000.

4. Can a Business Owner Base the Value of a Business on Earnings Multiples?

Another way to value a business, and perhaps a more useful measurement, is to use earnings multiples. This is a multiple of the company’s earnings, otherwise known as the price-to-earnings (P/E) ratio. This allows the business owner to predict the company’s earnings for the next few years. If a normal P/E ratio is 15 and the estimated earnings are $300,000, then the business is worth $4.5 million.

5. Can a Business Owner Base the Value of a Business on a Discounted Cash-Flow Analysis?

Another method used to determine the value of a business is to do a discounted cash-flow analysis. This analysis is a complicated formula that examines a business’ annual cash flow and predicts what it will look like in the future. It then reduces the amount of the future cash flow to today by using a “net present value” computation. Sounds difficult? Don’t worry! It is easy to find an NPV calculator online.

6. Does a Business’ Value Depend Only on Numbers?

A business owner should not, in fact, base the value of his or her business solely on numbers. There are a lot of factors that can impact the value of business. One of these factors is the geographic location of a business. Let’s say that a business focused on robotics is located in San Francisco. Because the city has a huge focus on modern technology, a buyer would find the location appealing, as they would be at the center of the industry with a lot of potential employees. Also, a business owner should consider the potential strategic value of his or her business. If the company is focused on robotics, for example, then it may be appealing to a buyer who has a business or interest in technology. That buyer would understand the value of the business, including any inventory or equipment. He or she would therefore have a better understanding of the business’ value and be willing to pay an appropriate price.

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