Knowing the market value of your business is important for many reasons, even if you aren’t thinking about selling anytime soon. By determining your business’s market value, you get a sense of what your company is worth beyond just income statements and balance sheets.
How Do You Determine the Value of a Small Business?
There are 3 main ways of thinking about your small business valuation: book value, present value, and fair market value.
Book value basically takes your balance sheet and values your company based on your assets minus your liabilities. Unless you are planning to liquidate, this isn’t a good way to calculate business value. In fact, you shouldn’t really consider assets when calculating a market value. A buyer won’t be interested in purchasing your company just to sell off your vehicles, property, and equipment—they will be interested in producing revenue from your company year over year.
Present value calculates your business’s value based on past and present data, like annual revenue. Most rule of thumbs methods of valuing a business calculate a version of present value. This can give you a good basic understanding of how much your business is worth.
Market value, in the end, is the most important number if you want to sell your business—this is the value that a buyer will pay for your business. While calculating the present value of your business can give you a baseline, the market value will ultimately be decided by—as the term suggests—the market.
What Is the Rule of Thumb for Valuing a Business?
There are 2 well-known rules of thumb for calculating a quick business valuation: percentage of sales and Seller’s Discretionary Earnings (SDE) multiples. While these formulas are quick, they won’t take into account all the unique aspects of your business. These methods are good for setting a baseline, but they won’t reveal the specific market value for your company.
Both methods require looking up either the SDE multiple or the percentage of revenue averages for your specific line of business. These multiples can be impacted by the size of your business and your location.
Percentage of Sales Method
The percentage of sales method of valuating a business is probably the most common way to quickly determine your company’s market value. While it is easy to calculate, it is pretty inaccurate because it fails to capture most of the specifics of your business.
To calculate your business value according to the percentage of sales method, start with your total revenue for a year. Then you must look up the average percentage of sales values for companies in your peer group. You can calculate your market value by using the percentage of your sales.
If the average market value of bars in your area is 30% of annual revenue and your bar brought in $1 million in sales last year, the market value of your bar is $300,000 according to this method.
SDE Multiples Method
SDE is a company’s annual EBITDA, meaning Earnings Before Interest, Taxes, Depreciation, and Amortization, plus the annual compensation paid to the business’s owner. SDE shows how much money a company brings in after non-essential expenses, taxes, and owner’s draw.
Your SDE doesn’t show your value in itself—that is where the multiple comes in. The SDE multiple is an industry standard that is between 0 and 4. Based on your industry, it estimates what your company is worth by multiplying your SDE by the multiple number.
If your SDE was $100,000 last year and your company’s SDE multiple is 2.5, the value of your business according to this method is $250,000.
How Much Is the Average Small Business Worth?
Business acquisition platform BizBuySell claims that the average American business sells for 0.6 times, i.e., 60%, its annual revenue.
This multiple, though, is probably inaccurate for most small businesses because industry, location, customer base, and intellectual property are much more important than the average value of all small businesses in the country.
A trendy startup could be worth $1 billion on the market, while a mom-and-pop dry cleaner will be worth much less. This is why the average value of small businesses doesn’t mean much.
How Much Revenue Should a Small Business Have?
The amount of revenue you should expect your small business to earn really depends on the size of your business, how long you’ve been open, your industry, your location, and the overall economy.
According to the US Census, the average American small business without employees, i.e. 1-person operations, earned about $47,000 in annual revenue. Businesses with 5 to 9 employees average just over $1 million in annual sales. The average revenue increases along with the number of people employed.
Remember, though, that revenue is not the only factor when determining your business’s value. Your intellectual property, market share, and other factors can significantly bolster your business valuation.