Rules of thumb and valuation formulas are a starting point in determining the value of a business. A standard rule of thumb is to value a business at a multiple of EBITDA (earnings before deducting interest, taxes, depreciation and amorization). The most useful formula for approximating value may be the discounted cash flow method which calculates the net present value of the future cash flows of a business based on certain assumptions.
Remember, however, that value is not the same as the price that is paid for a business. For many reasons, such as the relative bargaining positions of the parties and the skills of their negotiators, businesses are often purchased for more or less than their valuations. For instance, a business seller may be anxious to sell because of factors, such as family issues, that have nothing to do with the value of the business. Anxious sellers tend to accept prices that may be below the value of the business from an objective or market based perspective.
Nonetheless, having an accurate picture of the value of a business is essential in determining whether and how to proceed.
This post from The Entrepreneurial Mind summarizes a list from the Christman Group, LLC that equates value with price, but otherwise is instructive as to the types of factors that determine the value of a business for sale:
"Number 10: Industry Outlook
If the outlook for the industry is bright, the price goes up. Buyers look hard at the outlook for a company's gross margins, future growth projections, international economic factors, etc.
Number 9: Depth of Management and of the Sales Team
If an owner wears all of the hats, including generating most of the sales, the price will go down. A strong and experienced management team to operate the business is key value driver.
Number 8: Customer Base
If a company has limited customer concentration with no single customer representing more that 5-10% of revenues the price goes up. If the customer base is made up of “blue chip” companies, the price goes up too.
Number 7: A Good Story to Tell
Telling a company's story is critical in helping the buyer recognize the full value of a business. An extensive confidential offering memorandum that describes the business operation, the marketing and sales programs, its organizational structure, its facilities and equipment, its financial performance, and provides a financial analysis including a believable 5 year financial forecast.
Number 6: Stage of Industry Consolidation
If a company's industry is experiencing consolidating with the big companies getting bigger through acquisition, prices for smaller companies will rise.
Number 5: Company Track Record
If a company can show a track record of consistently growing profits and sales, buyers will pay more.
Number 4: Type of Business
A manufacturing company with a proprietary product will sell for more than a job-shop manufacturer. A distributor that adds value by offering installation, repair, and/or engineering/design will sell for more money than a non-value-added distributor. A service company with a special expertise will sell for more than a similar service company without this expertise.
Number 3: Revenue Size
The larger a company's revenues, generally the higher the price. A business with $25 million of annual sales will sell for more than a company with $5 million in sales.
Number 2: Market Position
A company that dominates its market or has a unique niche in the market will sell for a premium over other companies that do not dominate their markets.
Number 1: Having Multiple Buyers
When there are multiple buyers bidding on a business, the price of the business will exceed the price paid for a business that is sold without competitive bids."
