If you are a business owner you will need to value that business at some point. If your business is not publicly traded it can be confusing trying to figure out how to do it. Here are four ways to value a privately held business:
- Asset Method – this method uses the Balance Sheet and views the business as a collection of assets. Just add up the market value of the operational assets and subtract any operational liabilities and you have the value of the business. This method works well for asset intensive businesses (ex. Real Estate holding company) but it is not the best method for most operating businesses.
- Income Method – this method looks at the business as a stream of cash flows generated annually and capitalizes (or discounts) the income stream based on a risk rate. Start with Net Income from the P&L and adjust for any non-business or one-time expenses (ex. Personal expenses run through the business; sale of assets). This is the method that is most often used to value a privately held business but you need to be familiar with how to do it.
- Market Method – this method looks at sales of similar businesses to determine what yours might sell for. It is similar to how a realtor would value your home. Find other sales in your area; adjust for size and features; and then apply a common factor, like price per square foot, to your home to arrive at an estimated value. The problem with this method is that it is often difficult, or virtually impossible, to find a business similar to yours to compare to. Valuation professionals have access to transaction databases of thousands of businesses to help with this method.
- Rules of Thumb – This is simple and easy to use. For example, a rule of thumb for your industry might be 1x revenue or 3x earnings. Apply these factors to your business to estimate the value. But the trouble with rules of thumb is that they are based on averages, and most businesses are not average. If your business is above average then rules of thumb will result in a value that is too low.
At least one of the methods above will give you a good indication of the value of your privately held business. But don’t sell yourself short. If you are not comfortable doing the calculations, hire an experienced professional. You’ve taken all the time and effort to build the business so be sure you get all the value that you have earned. A valuation professional will typically consider all the methods above and then pick the one or two that best indicate the value of your business in its current situation.