Selling a business can feel complicated. Business owners must find the right buyer and set an accurate price before a purchase can go through. Undervaluations or overvaluations can harm the process and potentially prevent the original owner from getting what their brand is worth. Learning more about how to value a small business accurately could prevent that from happening.
What Is a Business Valuation?
A business valuation is how the owner determines the economic value of their business before selling it. People may start the process if they’re participating in a merger or acquisition. Valuation can also be necessary if the owner considers bringing on a new partner. Professional appraisers will look at numerous factors to reach their final estimation, including the brand’s market value, capital structure, and future earnings potential.
How Should Someone Approach Valuation?
While the valuation process has multiple steps, business owners should consider three primary steps before reaching their price point. A well-rounded perspective will present the most accurate information with less hassle.
1. Compare With the Market
Experts found that 2.8 million private-sector businesses started between 2021 and 2024. Many of those companies may have begun as a stepping-stone to more financial capital. Others may change hands when the original owners decide it’s best to move on.
No matter a person’s reasons for selling their small business, it’s crucial to compare a brand with its competitors to get an accurate idea of its worth. An appraiser will examine how the other companies grew and dealt with risks. A higher-risk business in a fluctuating market may get a lower estimate because there’s more potential for financial loss.
2. Calculate Tangible and Intangible Assets
Tangible assets are physical parts of a company, like the downtown storefront or the materials stored to make the brand’s products. Intangible assets add value to the business without being physical, like the brand’s stellar reputation or growth history.
A professional appraiser knows how to find and calculate those influencers on a business’s final price point. They also know how liabilities affect what they find. Once they add all of a brand’s assets, an appraiser will subtract the business’s liabilities, like any outstanding debt. The final number is the true asset valuation.
3. Factor Discounted Cash Flow
Discounted cash flow (DCF) accurately calculates the value of a present-day investment with a discount rate. The brand’s potential future cash flows become apparent when an appraiser considers the long-term value of money within an investment. If the multi-step formula predicts that a buyer will make little to no return on investment after purchasing the business, the brand will have a lower DCF. Companies with a higher DCF will be worth more because investors stand to make money.
Who Can Value a Business Before Selling?
Business appraisers and brokers can offer valuation estimates, but their processes differ. An appraiser will consider factors like asset-based and market method approaches, while brokers provide estimates using general market knowledge.
Business owners often contact appraisers first to get a precise valuation before working with a broker. Brokers coordinate the selling process more than appraisers. Both should have industry credentials, positive reviews, and experience with similar businesses before anyone works with them.
What to Prepare for a Valuation
An appraiser will need documentation to complete their valuation process. First, business owners should present comprehensive financial records. More extensive documentation from a brand’s complete history is always helpful. Appraisers may request things like:
- Quarterly or annual profit and loss statements showing revenue, expenses, and net profit
- Cash flow statements accounting for both outflows and inflows
- Balance sheets covering equipment, cash, inventory, and liabilities
- Debt payment schedules
- Any available accounts receivable and payable reports regarding a brand’s debts, invoices, and employee payment records
- Inventory records to compare stock orders and turnover rates
- Paperwork covering the owner’s salaries, discretionary spending, and perks
The paperwork may not include information regarding the company’s intangible assets, which the appraiser can investigate. Any documentation, like customer reviews and news articles, may suffice. Smaller businesses may only need a few weeks to finish the process, while brands with more complex cash flows or multiple locations could need longer. Gathering more documentation can make the process faster.
Common Mistakes Business Owners Make During the Process
Anyone starting a small business appraisal should know about common mistakes to avoid pitfalls. Business owners should ensure that all collected documentation covers every liability and contingent risk. For example, the appraiser should know if the business recently experienced a data breach that compromised sensitive consumer information, even if it’s difficult to discuss. If the information arises later in the brokerage process, buyers may leave for a more transparent opportunity.
Market conditions are also an important factor for business owners. Even if a brand survives economic upheavals like recessions, no one should assume their company can survive everything. Presenting research on similar businesses in the same industry and adjusting for macroeconomic factors is crucial for getting an accurate valuation.
People may also depend on appraisers with less experience who rely on a singular valuation method. When appraisers use a multi-faceted approach that considers factors like assets, discounted cash flows, and market data, business owners get better results.
Find the True Value of a Company
Getting the most accurate value of a small business requires a multi-method valuation from a professional appraiser before a broker gets involved. Business owners should request consultations with experienced appraisers who have worked with other owners in the same industry. The final result will be precise and quick if they get thorough documentation when their work begins.
Devin Partida is the Editor-in-Chief of ReHack.com, and is especially interested in writing about business and BizTech. Devin’s work has been featured on Entrepreneur, Forbes, and Nasdaq.
