Business Valuation 101
At some point over the course of owning your business, you’ll ask the question, “But what is my business worth?” The answer, of course, is “It depends.”
In this post, we’ll give you a quick rundown of some of the most common ways to value a business. In practice, no method is perfect, and that’s why we always recommend working with professionals you trust and who have a deep understanding of your industry and the M&A market.
Discounted cash flow
The Discounted Cash Flow (DCF) business valuation method is based on this concept: the value of any given business is equal to the sum of all future cash flows of that business, discounted to reflect their value today.
When applying the DCF method to a private company, assumptions will be made about that company’s cash flow, discount rates, control premiums, and illiquidity discounts. As you might imagine, this valuation method is only as good as the assumptions used to create the inputs. That is where your knowledge and experience as a business owner come into play. There is a large amount of discretion in projecting what a company’s business will look like for the next five to ten years, and if you are thinking about selling your business, you’ll need to defend each assumption you make.
Trading comp valuations determine the current value of a company using a sample of ratios from a comparable peer group of publicly traded companies. Bankers tend to prefer to use trading comp multiples to determine valuation because they reflect real-time, real-world valuation data.
The trick here is to make sure you have the right group of peer companies – companies that are the closest reflection to yours in terms of size, product mix, growth potential, etc. Bankers will ideally look at a peer group of somewhere between 5-15 businesses. Rather than simply looking at the group average, ideally, your team will focus on the companies that look most like your business and consider these companies’ multiples more heavily than the group’s average. Helping your team understand the key differences between the peer group and your organization can help them understand which companies are the most relevant to the valuation of your business.
Transaction comps consider the past sales of similar companies. A banker will compile a list of transactions that are relevant and comparable. An experienced banker will have an understanding of the market and what businesses similar to yours have transacted at. This approach to valuation will give you an understanding of the price and terms you should expect from a transaction.
For a deeper dive into these methods, check out this Guide to Private Company Valuation. If you are considering selling your business, please contact us for a confidential discussion of your specific situation. We have experience helping business owners across a variety of industries sell their businesses, as well as relationships with buyers who are interested in new opportunities.