Regardless of whether you are buying or selling a business, having a thorough and accurate valuation is a crucial part of creating a successful transaction. Whichever side you find yourself on, you may be wondering who is responsible for paying for the business valuation. After all, you don’t want to be left with the bill if the other party is ordinarily responsible for the valuation. 

In this article, we discuss who typically pays for business valuations. In addition, we cover:

• What is a business valuation?
• Who does business valuations?
• Why a business valuation is important

Related Article: 11 Elements That Impact Your Business’s Valuation Multiple

What Is a Business Valuation?

First, let’s explore what a business valuation actually is. A business valuation is a process for determining the current value of a given company. That is, it is an estimate of how much the owner could currently sell the business for. 

There are many ways to value a business, including:

• Fair market value
• Book value
• Times revenue method
• Liquidation value
• Market capitalization

When it comes to privately owned online businesses, the most common valuation method is the SDE multiple method. 

Understanding the SDE multiple method of valuation

According to the SDE multiple method, the value of a business is equal to the seller’s discretionary earnings (SDE) times a number, called the multiple. 

Business value = SDE x the multiple.

Simple, right? Well, not really. While (almost) anybody could multiply two numbers together to determine a value, accurately calculating the SDE and the multiple requires a high degree of knowledge and experience. 

“When it comes to privately owned online businesses, the most common valuation method is the SDE multiple method.” 

What is SDE?

The seller’s discretionary earnings is the amount of money the business generates that is available to the owner for discretionary (optional) spending. In other words, it is the total benefit the business provides to the owner (hence why SDE is also sometimes called the “owner’s benefit”). 

That sounds a lot like income, right? Not quite. To calculate SDE, start with income and add back all allowable expenses and income. This typically includes:

• Interest
• Taxes
• Depreciation
• Amortization
• Owner’s salary
• Noncash expenses
• One-time investments

SDE captures the true money-generating capacity of the business, or what the owner actually makes from the business. As such, SDE is usually higher than the official income of the business. 

What determines the multiple?

You may be tempted to look at the SDE of a business and extrapolate a value solely based on that figure. In this scenario, all businesses with the same SDE would have the same value. However, this is certainly not the case. 

Two businesses with identical SDE figures could have dramatically different values. Imagine two businesses with the same SDE figures, but one is the target of a patent infringement lawsuit and one has a clean legal slate. Which would you be willing to pay more for?

These discrepancies are captured by the multiple. The multiple incorporates tangible and intangible aspects of value into the valuation process. Many individual factors can impact the multiple. For simplicity, these factors can be grouped into four main categories, known as the Four Pillars of Value. They include:

• Growth
• Risk
• Transferability
• Documentation

Businesses with stronger growth records are more valuable than those that have been stagnant or in decline. The more risk a business has, the less valuable it will be compared to others. If a business will have a difficult time transferring to a new owner without harming profitability, it will be less valuable than an easily transferable business. And lastly, businesses with clean and orderly documentation are more attractive (and thus more valuable) than businesses with disorganized or incomplete documentation. 

“Two businesses with identical SDE figures could have dramatically different values.”

Who Does Business Valuations?

At this point, we know a little bit about how business valuations work, but you might be wondering who values businesses. As a business owner, who can you reach out to to get an accurate valuation of your company?

There are many different ways to go about getting a business valuation. Several of the popular methods include:

• Business valuation calculators
• Accountants
• Valuation specialists
• Business Advisors or business brokers

Business valuation calculators

The first option on this list is not an individual, but an online tool. Many business owners are tempted to use business valuation calculators to determine the value of their business. These tools are easy to use and often free. 

What you gain in convenience you are likely to lose in accuracy, however. Unfortunately, these tools do not always do a great job of determining the real value of your business. There are many reasons for this, the most obvious of which is that the valuation calculator does a poor job of taking into account the many factors that go into determining the value of the multiple. 

Accountants

Accountants who are trained in valuing businesses and have experience in relevant markets can often provide accurate valuation assessments. However, you must make sure that your accountant has the relevant experience and expertise to do the job correctly. 

Valuation specialists

A valuation specialist, also called a Certified Valuation Analyst (CVA), is an individual who has undergone training and certification explicitly to assess the value of businesses. Given their training and (hopefully) extensive experience, these individuals can generally be trusted to create accurate valuations. Again, however, it is important to choose a CVA who has relevant experience in your business’s industry and market. 

Business Advisors or business brokers

Business brokers (also called business Advisors) are individuals who help others sell or buy businesses. You can think of them as real estate agents for businesses. Business Advisors are immersed in the fine details of owning, running, buying, and selling online businesses. In fact, most Advisors are also successful entrepreneurs.

One of the main roles of a business Advisor is valuing businesses. If you are a seller working with an experienced business Advisor, you can rest assured knowing they have the ability to provide a thorough and accurate valuation of your company. 

“One of the main roles of a business Advisor is valuing businesses.”

Does the Buyer or Seller Pay for the Business Valuation?

So, who actually pays for the business valuation? The simple answer is that the seller typically pays for the valuation. If you are the business owner, you are responsible for getting a quality valuation prior to putting your business on the market. 

Accountants and valuation specialists may charge you a flat fee for a valuation. In this scenario, the valuation may be a stand-alone service. Business Advisors, on the other hand, typically work a little differently. 

Most Advisors who are helping you sell your company will include the valuation as part of their overall services. You don’t pay for the valuation up front as you would with an accountant or valuation specialist. 

Instead, the business Advisor would receive an agreed-upon portion of the proceeds of the sale of your business. In this way, they get paid alongside you when the business sells. 

“If you are the business owner, you are responsible for getting a quality valuation prior to putting your business on the market.” 

Why a Business Valuation Is Important

Getting a professional business valuation can help you:

• Determine a reasonable listing price
• Plan your finances
• Optimize your business operations
• Increase the value of your business

Determine a reasonable listing price

The most obvious benefit of an accurate business valuation is to determine a fair price at which to list your business. As a seller, if you list your business too high, educated buyers will see through the ruse, possibly negatively impacting your sale. List it too low and you leave valuable money on the table. 

Plan your finances

As a business owner, your company may very well be your most valuable asset. Regardless of whether you plan to sell your business now or in the future, knowing how much you are likely to get for it will help you plan your future finances more accurately.  

Optimize your business operations

A thorough business valuation by a trained professional does more than simply tell you an accurate dollar amount. It also explains why your business is valued the way it is. This includes a deep dive into its strengths and weaknesses. You can then use this information to address the areas of your business that need attention, streamlining your operations in the process. 

“Regardless of whether you plan to sell your business now or in the future, knowing how much you are likely to get for it will help you plan your future finances more accurately.”

Increase the value of your business

As you take steps to optimize your business based on the information you gained from your valuation, the value of your business is likely to go up. For example, if you clean up your financial documentation, mitigate legal risks, and drive growth, your SDE and multiple will increase, ultimately raising the value of your business. 

As it turns out, valuations can be a tool to increase your bottom line in addition to creating a successful exit.