Demystifying Small Business Valuationhttp://www.buysellbusinesses.comSmall Business Valuation
Demystifying Small Business Valuation Valuing businesses is of paramount importance toa small business. It is one of the several metricsused to ensure the business is growing andcreating value for the owners. There are several valuation methods one can useto determine the intrinsic value of a company. Valuation techniques are broadly classified as Asset value methods Earnings value methods and Market Value based methods
Demystifying Small Business Valuation The valuation techniques are based on discountedfuture cash flow (DCF), discounted future earningsand industry specific multipliers. Rules of thumb are commonly used by businessbrokers to determine the price of a business andsimplify the valuation process. Values determined using “Rule of thumb” aresimplifications and only an estimate of the truevalue of the business. “Rule of thumb” must be used as a staring pointbefore conducting detailed due-diligence todetermine the correct value.
Demystifying Small Business Valuation A common approach to valuing a business is to useearnings or sales multiples. This approach directly addresses a buyer’s motive ofestimating the return on investment (ROI) on deals.
Demystifying Small Business Valuation Real Estate is historically priced at 8 to 10 timesits net operating income (EBITA). Stock markets are typically priced at 12 to 20times earnings. These multiples do not apply to small businessesas the risk premium associated with a smallbusiness is much higher than managing abuilding or a stock portfolio. The first step us to determine which multiplier touse. factors to consider include determining thecomposition of earnings. Generally the preferred earnings to use are
Demystifying Small Business Valuation Normalized earnings are adjusted for cyclicalchanges in in the economy and one time one-time influences. The multiplier is based on risk and there usuallyare “Rules of Thumb” multiplier numbersdepending on the industry. Tangible and Intangible assets have a value thatis separate from the business. Therefore the best way to treat tangible/intangibleasset is to separate them from the business andthen add them back to the multiple derived valueof the business. Multiples used are very specific to a business andlocation of the business but broadly speaking itcan be between 2 to 5 times normalized EBIT
Disadvantages and caveats In reality there is no perfect price and techniquesdescribed in the earlier sections are justguidelines to derive an acceptable price. The “Rules of Thumb” approach does not providesufficient information to assess the uniqueness ofthe business, such as management depth,customer relationships, industry trends,reputation, location, competition, capital structureand other information that is unique to thebusiness. Proper evaluation will go beyond calculationsbased on multiples and tangible/intangible assetvalues. It requires complete business, marketingand financial due-diligence.
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