Valuation Explained, Part 1: How to Value Your Existing, Revenue-Generating Company

If you’re thinking about selling your established business, you will want to take some time to gather as much information as you can. One of the most important things that you will want to do is to get a valuation for the business. The following are some key things to understand about how to go through this process.

Understanding EBITDA

EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, is an important number when getting a valuation on your company. With well kept financials, determining the EBITDA for your company can be quite simple. It really is the Net Income + Interest + Taxes + Depreciation + Amortization. EBITDA can show you how profitable the business is without some of the effects of financing and capital expenses.

When it comes to selling your business, potential buyers will often start by assigning a set multiple of your EBITDA to decide how much they can pay. For example, if your EBITDA is $500,000 and the buyer sets their multiple at 4x, then they would be willing to pay $2 Million for the business. Determining what multiple they will use will depend on factors such as what industry your business is in, the trends in the industry, and other variables.

Understanding Drivers

Often, business owners are getting valuations so that they can accurately estimate how much they will be able to get from a buyer in the sale. But, what sellers really should be doing is getting a valuation much earlier than needed to establish a baseline value and understand the drivers of the business that will help increase the sales price. In my opinion, the baseline valuation should come years before a seller wants to sell. This will give the entrepreneur time to implement, fix, or otherwise focus on the “drivers” that are going to maximize the sale price. These drivers can range from business-to-business. Some that come to mind include revenue growth, sales conversion rates, lifetime value of a customer, customer concentration, customer churn, etc.

Using the Valuation for Capital Raises?

When most people think about selling a business, they think about selling the entire business to retire or start something new. For many business owners, however, the valuation can serve as a tool for them to raise capital. However, one thing to keep in mind when using a valuation for capital raises, often a just a part of the company is less valuable due to lack of control (the entrepreneur may remain in control). Thus, you may see a “minority discount” attached to the value of that particular interest. In addition, there are other monetary factors (e.g., preferential returns) and non-monetary factors (e.g., decision making authority or veto authority) often come up in a financing transaction that can cause a valuation to be “overly simple” for the circumstances.

Click here to read another post entitled “Need Funding? Four Ways to Raise Capital For Your Business”.

Make Sure Everything is Handled Correctly

Whether you are selling the business outright or attempting to raise money to grow your business, you need to make sure everything is handled properly. While our firm doesn’t perform valuations for clients, we certainly have good referrals for this sort of work. In any case, a valuation can come in hand for the work we do for clients. Contact us should you need assistance with these types of matters.

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