Buying a Business

How to Value a Small Business for Sale: Steps by Step Guide

As a small business owner, you've probably put your heart and soul into building and growing your business. Now, whether you’re retiring, relocating, or just moving on to another venture, it might be time to sell your business. But how much is it worth? The value of your small business depends on multiple factors, and it can be confusing to determine its actual worth.

In this guide, we’ll walk you through the process of valuing your small business for sale, step by step. From the methods to the factors to consider, we'll provide you with all the information you need to understand its worth like a pro.

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Step 1. Find a Professional Business Appraiser

If you're looking to sell your business, finding a professional business appraiser should be your first step. This expert's evaluation of your company's worth will not only provide you with a clearer understanding of your business's value but will also guide you in making important decisions about the sale. Knowing the value of your business will also ensure that you don't undervalue it, potentially resulting in a less profitable sale for you.

So where do you start? Begin by asking for recommendations from your financial advisor, attorney, or local Chamber of Commerce. Taking the time to find the right appraiser will be an investment that pays off in the long run.

Step 2. Pick Your Valuation Method

Before you even think about putting a price tag on your business, you need to decide which valuation method you want to use. There are three primary methods: the Income Approach, the Market Approach, and the Asset Approach. Typically, a professional valuation expert will use a combination of these methods to come up with a more accurate valuation, but it's important to be aware of your options.

The Income Approach

The Income Approach calculates the value of your business as its predicted future earnings. This approach involves determining the present value of future cash flows that the business is expected to generate. Essentially, it's looking at the potential economic benefits of the business and putting a price tag on them. To do this, various factors, such as the business's revenue, expenses, growth potential, and risk, are taken into account to calculate the potential earnings. This approach can be particularly useful for businesses that have a proven track record of generating steady profits

The Market Approach

The Market Approach compares your business to similar ones in your industry that have sold. It looks at factors such as industry trends, financial performance, and market demand in order to assess the value of the business in question. By using the market approach, potential buyers can make informed decisions based on real-world data rather than just guesswork. It's important to work with a professional business appraiser to ensure accurate valuations, as the process can be complex and involve many variables.

The Asset Approach

This approach takes into account the tangible and intangible assets of the business, such as equipment, inventory, and brand value. By adding up these assets and subtracting any liabilities, an estimate of the business's value can be calculated. Additionally, this approach can be particularly useful for companies that have a lot of tangible assets, such as manufacturers.

However, it's important to note that this method only provides a snapshot of the company's value and may not fully account for factors like revenue trends or industry shifts. Consulting with a professional valuator can be incredibly helpful in determining the most accurate valuation for your business.

Step 3. Organize Your Business Financials

Your small business’s financial statements are critical in determining your business's value. You need to gather all the financial information and records for the past three years. This includes income statements, balance sheets, P&L, and cash flow statements. The financials should show the history of your business finances and a projected cash flow.

However, if your business finances are behind or unorganized, it can be a major obstacle to selling your business. This is why it might be important to hire a bookkeeper who can help you get your finances organized and in good shape. With their help, you can ensure that all of your financial records are up-to-date and accurate, making the process of selling your business much smoother.

Step 4. Adjustments

Generally, the person tasked with making these valuations is a professional business appraiser. These appraisers possess extensive knowledge and experience in analyzing businesses to determine their fair market value. They take into consideration factors such as industry trends, financial performance, and potential growth, as well as any unique aspects of the business.

No two businesses are alike, and therefore, an expert valuation must make adjustments for differences in size, location, risk, and market conditions. For example, if your business is located in a low-traffic area, an adjustment will be made for your likely reduced customer base.

Step 5. Understand Your Intangibles

Aside from the financials and adjustments, intangible assets also play a vital role in the valuation of a small business. These are things like customer lists, patents, brands, trademarks, and more. The valuation expert must determine whether these items can transfer or whether transferability is limited. Limited transferability can have a negative impact on the overall enterprise value of your small business.

Step 6. Consider Market Forces

Finally, market forces also come into play when assessing the value of your small business. It’s essential to understand the market conditions affecting your business value and trends in your industry. Market forces include industry, demographics, legal, environmental, and technological changes. Understanding these factors helps to evaluate the reasonableness of your estimated value from a market perspective.

While it may be difficult to predict the perfect time to sell, there are certain indicators that can help you determine whether the market is in your favor. For instance, if the economy is booming and businesses are thriving, it may be a good time to sell, as buyers may be willing to pay a premium price. On the other hand, if the economy is in a slump, it may be better to wait until conditions improve. Ultimately, the best time to sell your business is when you feel ready and when it makes the most sense for your personal and financial goals.

As always, consulting with industry professionals and business brokers can help you make an informed decision based on your goals.

Keep Growing Your Business for a Successful Sale

In conclusion, valuing a small business is more of an art than a science. Every business is unique, with individual strengths, weaknesses, and risk factors. While tackling the job yourself might be tempting, we recommend that you seek advice from a professional valuation expert. A business broker can help achieve the best outcome based on a detailed business valuation.

Whether you are planning your exit now or in a few years, keep your business growing to ensure you have a strong exit when the time comes. Subscribe to our newsletter to get the best business finance and growth tips.

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