Chapter 3: Business valuation — what is it worth?

There is no objective, correct price for a business. The price is what a specific buyer is willing to pay and you are willing to accept, on the terms you agree. But a thorough valuation gives you a realistic starting point, makes it easier to argue for your price and protects you from either selling too cheaply or scaring buyers away with an unrealistic price. This chapter covers the methods used to value businesses in practice — normalisation, EBITDA, multiples, DCF and net asset value — and you can get a first, indicative figure with Sitavo’s free valuation calculator.

Start with normalised earnings

Almost every method is based on the business’s earnings. But the profit in the accounts is rarely what a new owner can expect. That is why earnings are normalised: you adjust for items that will not continue after a change of ownership, so that the figure shows the real, recurring earning power.

Typical normalisations

• Owner’s salary: If you have drawn a salary lower or higher than the market rate for the role you fill, it is adjusted to a market salary. If you take no salary at all, a realistic salary must be deducted for whoever will do your job.
• Private expenses: Car, phone, travel and anything else that is in reality private are added back.
• One-off items: For example a lawsuit, a move, a large one-off order or an exceptional write-down.
• Rent paid to related parties: If you own the property yourself and rent it to the business, the rent is adjusted to market level.
• Family members on the payroll: Salaries that don’t reflect a real work contribution, or work done for free.
• Non-operating items: For example interest income from surplus cash or investments that are not included in the sale.

EBITDA, profit and SDE — which figure?

It is important that you and the buyer are talking about the same figure. A multiple of SDE is not comparable with a multiple of EBITDA, because SDE includes the owner’s salary. Always state in the sales material which figure is meant and how it has been calculated.

The multiple method

The most widely used method in practice is to multiply normalised earnings by a multiple. The multiple reflects how many years of earnings a buyer is willing to pay for — and therefore how much risk and how much growth the buyer sees. The formula is simple: value = normalised earnings × multiple. The skill lies in choosing the right multiple.

What pushes the multiple up or down?

Indicative ranges

The ranges below are rough rules of thumb for smaller businesses and are intended only as an initial guide. The actual multiple depends on all the factors above, on market conditions and on the specific buyer. Deviations in either direction are entirely normal.

DCF — discounted cash flows

The DCF method (discounted cash flow) values the business on the basis of its future free cash flows, discounted to today at a rate that reflects the risk. In theory it is the most correct method, but it is very sensitive to its assumptions: small changes in the growth rate or discount rate can shift the value considerably.

1. Forecast the free cash flows (operating profit after tax, minus investments and change in working capital), typically for 3–5 years ahead.
2. Set a discount rate that reflects the risk. Smaller and less certain businesses get a higher rate.
3. Calculate a terminal value for the years after the forecast period.
4. Discount the cash flows and terminal value to present value and add them together.
5. Deduct net interest-bearing debt to arrive at the value of the equity.

For most small businesses, DCF is used mainly as a supplement — for example to test whether the multiple-based value is reasonable, or to value a fast-growing business where historical figures don’t tell the whole story. Ideally, have your accountant do the calculation.

Net asset value

Net asset value is the value of the business’s assets minus its debt. It is relevant for businesses with low or negative earnings, where the value lies mainly in equipment, machinery, stock or property. Net asset value often acts as a floor: a buyer rarely pays less than the assets are worth — but not much more either, if the earnings cannot support it. The difference between the price and the net asset value is called goodwill — read more about how it is measured and taxed in Goodwill.

From value to asking price

• Use several methods and see whether they point in the same direction.
• Compare with the market: See what similar businesses are listed for on Sitavo — but remember that the asking price is not the selling price.
• Leave room for negotiation, but avoid a price so high that serious buyers pass you by.
• Choose the pricing format deliberately: With “Open to offers” you show an asking price and can set a minimum offer, so offers below it are declined automatically. With “Price not disclosed” buyers bid freely. If several parties are interested, a bidding round or an auction can test the price — see Bidding rounds and auctions.
• Think structure, not just price: A slightly lower price paid in cash can be worth more than a higher price with a large earn-out.