As a business owner, your company is likely your most valuable personal asset. But do you really know how much your business is worth? For many entrepreneurs, it can be difficult to have an accurate understanding of business value. However, knowing how much your business is worth is crucial to running a successful operation and maximizing your profit when you do decide to sell. 

In this article, we discuss several key aspects related to understanding how much your business is worth, including:

• The importance of determining business value
• How to figure out how much your business is worth
• Key considerations when valuating your business
• How to simplify business valuations with Quiet Light

Related Article: Understanding Valuation Metrics for Business Owners

The Importance of Determining Business Value

Determining the value of your business provides you with a specific, accurate dollar figure describing how much it is worth. While knowing this number is certainly helpful, it is only one of the many benefits of determining your business’s value. 

When you valuate your business, you take a deep dive into its operations, strengths, weaknesses, and more. Most entrepreneurs come out of the process understanding their business in a whole new light. Along with the specific dollar value, this new knowledge allows you to:

• Plan for the future
• Grow your business’s value
• Make your business easier to run
• Achieve a more successful exit

Plan for the future

Knowing how much your business is worth allows you to plan for your professional and personal future. It can help you decide whether or not you want to sell the business, and if so, when you would like to sell. It can help you understand what your retirement plan looks like or give you a better idea of how much house you can afford. 

Without knowing how much your business is realistically worth, it can be difficult to make informed decisions and accurately plan your future. Getting a valuation is one of the best things you can do to bring clarity to your finances and help you move forward from a position of strength.

“Knowing how much your business is worth allows you to plan for your professional and personal future.”

Grow your business’s value

As mentioned, you will learn a lot during the valuation process. As you come to understand your business on a deeper level, you will have a better understanding of the true drivers of business value. This knowledge, in turn, will allow you to make targeted changes to grow your business’s value moving forward. 

Make your business easier to run

Business value is only one measurement of business success. The ease or difficulty of running your company plays a large role in determining your ownership experience. If you have a highly valuable business but it is killing you to run, it might be time to step back and reconsider priorities. A highly valuable company that requires minimal time and effort to maintain, however, is a truly wonderful asset. 

A thorough valuation process will help you understand how you can make your business easier to run. As you automate and systematize your operations, you will have more free time to invest in growth or spend doing other things that you love. In addition, when it comes time to sell, you will attract more buyers and have a better shot at achieving a successful exit. 

“A thorough valuation process will help you understand how you can make your business easier to run.”

Achieve a more successful exit

Valuating your business can provide you with the insight and knowledge needed to achieve a truly successful exit. This is accomplished by learning what drives business value, understanding how your business stacks up, and making improvements before listing it for sale. 

By doing so, you can expect to attract more interest from qualified buyers. The more interest you gain, the more competition there will be for your business. This drives up the value of your business and gives you more power as you negotiate with buyers. This, in turn, can help you achieve better deal terms and a smoother transaction process. 

All of this is made possible by first understanding what drives the value of your business. 

How to Figure Out How Much Your Business Is Worth

There are many different ways to valuate a business. However, the most commonly used method for online businesses (and the method we use here at Quiet Light) is the SDE multiple method. Below, we will explain this method and break down the underlying drivers of business value. 

The SDE multiple method of business valuation

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

Business value = SDE x the multiple

While it looks simple on the surface, a lot goes into determining both the SDE and the multiple. 

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

SDE explained

The seller’s discretionary earnings is the money the business generates that is available to the owner for discretionary purposes, i.e., purposes of the owner’s choosing. It is similar to income, but there are some key differences. Whereas income is the amount of money left over after all expenses are incurred, SDE is the amount of money left after all nondiscretionary (required) expenses have been paid. 

To calculate SDE, start with income and add back all allowable discretionary expenses, including:

• Interest
• Taxes
• Depreciation
• Amortization
• Owner’s salary
• One-time investments
• Unrelated income or costs

SDE is also called the owner’s benefit. It sums up the total value that the business provides to the owner. Business owners can use discretionary expenses to minimize income for tax purposes, distorting the true value that the owner derives from the company. In comparison, SDE more accurately describes the full money-generating capacity of the business. As such, it is a better figure to use when comparing two or more businesses to each other. 

SDE is not always easy to calculate, especially for those without knowledge of the valuation process. While financial statements contain the information necessary to make the calculation, you must know which expenses count as discretionary and which do not. At the same time, any errors in calculating SDE can lead to large differences in overall business value. 

For this reason, many business owners choose to work with a qualified business Advisor throughout their valuation process in order to ensure accuracy. 

The multiple

Imagine two businesses with equal SDE figures. On the surface, you may assume they have the same value. However, one requires 60 hours of the owner’s time per week and is facing several lawsuits, and the other requires four hours of the owner’s time and has no legal troubles. Which would you be willing to pay more for?

Clearly, a business’s value also rests on many factors other than how much money it generates. The multiple serves to asses these tangible and intangible aspects of a business’s value.

It is helpful to categorize all of these individual factors into four main categories known as the Four Pillars of Value. They are:

• Growth
• Risk
• Transferability
• Documentation

The Four Pillars of Value

Buyers want to buy a business that yields a high return on investment. One of the best ways to achieve a high ROI is to purchase a business that is likely to grow long into the future. Past and current growth trends often indicate a higher likelihood of future growth. As such, businesses with strong growth are valued higher than those that are stagnant or in decline. 

All businesses entail some risk of failure. However, businesses that are considered riskier than others will be less attractive to potential buyers. This, in turn, lowers their value. 

“If you have a profitable company but don’t keep clear accounting records, buyers will be less interested than if you keep orderly records.”

If your business can’t transfer to a new owner without negatively impacting its performance, you will have a hard time attracting qualified buyers. The ones that you do attract will be willing to pay less than they would if your business was easily transferable. 

Lastly, the state of your business documentation plays a role in the assessed value of your company. If you have a profitable company but don’t keep clear accounting records, buyers will be less interested than if you keep orderly records. 

Together, these factors shape the overall value of your business. As you go through the business valuation process, you will get a much clearer picture of how your business stacks up on each of these Pillars of Value. 

This is where valuations can be extremely beneficial. Armed with this knowledge, you can then work to improve the areas of your business that need help. For example, suppose you have a growing business with minimal risk but poor documentation and barriers to transferability. In that case, you can improve your documentation and decrease barriers to transferability prior to selling it. Even if SDE stays the same, these changes would serve to increase your multiple and increase the overall value of your business. 

Key Considerations when Valuating Your Business

As a business owner, there are several key considerations you should take into account when valuating your business. 

“Valuation calculators can be helpful in a limited capacity, but they should not be relied on to provide accurate or thorough valuations.”

Business valuation calculators: Do they work?

For starters, you may have heard of online business valuation calculators. Many owners turn to these tools to provide easy assessments of business value. But do they work, and are they worth your time?

The short answer is that valuation calculators can be helpful in a limited capacity, but they should not be relied on to provide accurate or thorough valuations. Even if you could plug in an accurate SDE figure, there is no way that an online valuation calculator could take in and interpret all of the tangible and intangible assets that determine business value. There are simply too many nuances in the equation. 

In addition, many of the benefits of a business valuation come from learning about your company’s strengths and weaknesses. A valuation calculator only spits out a number (often inaccurate). In order to truly understand your business’s value, you will need to work with a valuation professional. 

What to look for in a business valuation professional

A qualified business valuation professional, or business Advisor, is your best bet for receiving an accurate and thorough valuation. When choosing a valuation professional, there are a few factors to consider. 

For starters, look for one who will provide you with a realistic estimate of the value of your business. As an owner, it can be easy to get carried away with overestimating the value of your business. Your valuation professional should be willing to push back against your expectations and tell you when your ideas are unrealistic. 

They should also have relevant business structure and industry knowledge. For example, if you run a B2B SaaS business, they should have extensive experience valuating similar companies. Since your business is valued in comparison to others, a working knowledge of the market and competition is crucial. 

“Your valuation professional should be willing to push back against your expectations and tell you when your ideas are unrealistic.”

When you should get a business valuation

Many business owners wait until right before they plan to sell to get a valuation. While an accurate valuation is crucial prior to selling, there are many other occasions when it could be helpful. 

As we have seen, getting a valuation is an important step in preparing your business for sale. The knowledge you gain in the valuation process helps you to make improvements. As such, you may benefit from getting a valuation 12–24 months before you plan to sell it. This will help you plan your financial future and home in on the aspects of your business that need attention. 

Simplify Business Valuations with Quiet Light

Our business Advisors have extensive experience helping our clients create profitable and successful business exits. As part of the process, we provide confidential valuations for individuals considering selling their business. Reach out to us to learn more about our valuation process and get the ball rolling on your exit today.