Pricing your business is an exciting undertaking. However, determining the exact selling price of your small business can be challenging, as business valuation is very subjective. There are multiple ways to calculate the selling price of a small business, but not everyone agrees on the best method. Working with a business valuation expert like Exit Your Way can guarantee you an accurate valuation. Below is a breakdown of the commonly accepted ways to calculate the selling price of a small business.
1. Return on Investment Method
Under this approach, what matters is your business’s annual net profit minus the probable salary to pay your replacement. Your annual net profit is what remains after you’ve paid all expenses, such as salaries, cost of goods, rent, and taxes. You should deduct that from what it would cost your replacement. This is because potential buyers view your business as an investment and want to be certain of what remains after replacing the management.
This small business valuation method is most likely the most objective from an investor’s point of view. A major drawback with this method is that it may undervalue businesses where the owner’s industry expertise is a key driver of success.
Buyers seeking to maximize their ROI can’t automatically assume that they can employ a replacement likely to attain similar outcomes. This increases the difficulty of pricing a small business with a superb reputation and a charismatic owner since buyers can’t count on hiring an equally excellent manager to replace you. In such cases, you can get a higher amount from the buyer if you agree to stay in management a little longer.
2. Sales of Comparable Small Businesses
Comparables is a term when evaluating the price of a business based on similar ones with similar traits. Under this approach, your small business should be worth what someone was willing to pay for another similar company.
Look at what businesses similar to yours have recently sold to help you price yours. While finding recent comparables for small businesses may be challenging, it is a reliable method to determine the approximate selling price.
3. Asset Value Method
This method starts by totaling a business asset’s value. In most businesses, asset value depends on the asset’s location within the venture. When you remove the asset from the business and sell it as a generic product, its value reduces. Considering asset value is practical in most cases, especially if the small business owns valuable trademarks, copyrights, and patents.
4. The Industry Formula Method
Most financial information service websites provide multiple approaches to price a business based on “the rule of thumb” for a specific venture. For instance, a common rule of thumb for evaluating E-commerce businesses is that a profitable E-commerce business is valued at 3X – 6X its annual profits. This approach may be limited where two small businesses have different asset bases.
5. Future Value Method
This approach determines a small business’s current value, taking into account current income and a predicted growth percentage for the future. The current value is calculated for a certain time period.
The current income value that a small business generates is multiplied by the estimated growth percentage. This percentage tends to be highly subjective and depends on multiple variable assumptions.
6. Income Multiple
You can calculate the value of a small business on the basis of owner benefits multiplied by an income multiple. The value determines the amount of money a potential buyer can reasonably hope to get from your small business in the possible future.
A small business’s income multiple typically falls between 1 and 3. This will depend on the type of trade and the small business’s track record. The income multiple increases the higher the owner benefits get. On the contrary, the income multiple will fall well below 1 if the success of the small business is closely associated with the business owner or limited by the industry. The assumption is that customers will easily follow the seller and it could be harder for the new business owner to gain new customers.
Key Takeaway
Pricing a small business for sale requires considering many factors. Hiring a professional, such as the team at Exit Your Way, can save you the hassle and time of doing this and get your business priced appropriately. Check out our Sales Consulting Service here
Professionally calculated selling price can increase the accuracy of your business valuation, whether you’re considering selling or buying one. Need more insights on this topic? Download our free Business Sale Guide by clicking here. This comprehensive guide will provide you with additional details and considerations to help you evaluate the value of your small business accurately.
Ready to make an informed decision about selling your business? Don’t hesitate to book a call with Exit Your Way. Our team of experts is ready to provide the guidance and support you need to navigate this important financial decision, just click here.
