how to valuate a small business

Valuing a small business involves combining several methods to arrive at a realistic range rather than a single number. The most common approaches look at profits, assets, and market comparables, adjusted for risk, growth, and owner involvement. Here’s a practical, task-focused guide you can follow. Key valuation approaches

• Earnings-based/value of cash flow
  • Multiply normalized earnings (e.g., net profit or EBITDA) by an appropriate multiple for the industry. Multiples typically range from about 2x to 6x for many small businesses, but can be higher for fast-growing or highly recurring-revenue models and lower for asset-light or owner-dependent shops. Consider factors that affect the multiple: customer concentration, recurring revenue, margins, growth trajectory, and competitive position.
  • Normalize earnings: adjust for non-recurring expenses or revenues, owner salary that wouldn’t be necessary for a new owner, and any discretionary costs.
• Asset-based (book or liquidation value)
  • Book value: Assets minus liabilities as shown on the balance sheet. This can understate value for service businesses with strong brand, client lists, or proprietary processes.
  • Liquidation value: what remains if assets must be sold quickly. Generally lower than ongoing business value but useful for scenarios like wind-down or distressed sales.
• Market/comparable sales
  • Look at recent sales of similar businesses in your industry and region. Use revenue or earnings multiples observed in those deals to triangulate a reasonable range for your business.
  • Adjust for differences in size, client base, contract depth, and risk profile.
• Other methods worth noting
  • ROI-based (return on investment) framework: if you know the price you want (or ROI you require), you can solve for a selling price or target ROI using net profits.
  • Book value plus intangible value: consider IP, customer relationships, brand, and staff expertise that aren’t captured on the balance sheet.

Step-by-step practical process

1. Gather financials

• Compile at least three years of income statements and balance sheets.
• Normalize earnings: remove owner-specific expenses, non-cash charges, one-time costs, and any unusual revenue spikes.
• Calculate key metrics: Seller’s Discretionary Earnings (SDE) for small, owner-operated businesses; EBITDA for businesses with multiple owners or more formalized reporting.

2. Compute core values

• Earnings-based value: determine a reasonable EBITDA or SDE and apply a range of industry multiples (lower, typical, upper). For example, if normalized EBITDA is $120,000 and the market suggests 3x–5x, the rough value range would be $360,000–$600,000.
• Asset-based value: calculate total assets minus total liabilities to obtain a baseline. For asset-heavy businesses, this can be a meaningful floor.
• Market comparables: identify 3–6 similar deal examples and extract multiples; triangulate a mid-point within the observed range and adjust for your specific risk factors.

3. Adjust for situational factors

• Customer concentration: a small share of revenue from a few customers may reduce the multiple.
• Recurring revenue and contracts: recurring or predictable revenue tends to support higher multiples.
• Growth potential and barriers to entry: scalable systems, defensible market position, or proprietary processes can lift value.
• Owner involvement: if the buyer will need significant owner support post-sale, consider a lower multiple or an earn-out structure.

4. Prepare a valuation range and a CV

• Present a value range rather than a single number.
• Create a concise “Valuation Summary” with:
  • Method(s) used and resulting values
  • Adjustments made (normalizations, risk factors)
  • Final recommended range
  • Key assumptions (industry, growth rates, margins)

5. Validate with professionals

• If possible, consult a business broker, a certified valuer, or an M&A advisor who understands your industry. They can refine methods, stress-test assumptions, and provide market-tested ranges.

Practical tips and pitfalls

• Don’t rely on a single method. A composite view reduces overreliance on one assumption.
• Be transparent about normalization. Clear documentation helps buyers understand the value drivers.
• Be mindful of tax and legal implications when structuring the sale (e.g., asset vs. stock sale). Seek professional guidance.
• Prepare robust due diligence materials: historical financials, customer contracts, supplier agreements, employee matters, and any litigation or compliance issues.

Common pitfalls to avoid

• Overstating recurring revenue or underestimating churn.
• Ignoring hidden liabilities, such as leases, debt, or pending commitments.
• Relying solely on a glamorous revenue figure without validating profitability and cash flow.

If you’d like, share a brief snapshot of your business (industry, annual net profit or EBITDA, annual revenue, years in operation, owner involvement, and any strong recurring revenue or contracts). I can help you sketch a plausible valuation range and identify the most appropriate method(s) to emphasize for your situation.