Whether you’re contemplating selling your small business, understanding how to accurately value it is crucial. A precise valuation not only helps in setting a fair selling price but also attracts potential buyers who are looking for businesses based on Seller’s Discretionary Earnings (SDE) multiples. In this guide, we will break down the essential steps to value your small business for sale.
1. Comprehend the Valuation Process
Valuing your small business when preparing to sell is a vital step in the process. You’ll often hear the term SDE multiple, which is a common valuation method for small businesses. It’s particularly relevant for owners actively involved in the business’s daily operations, as it includes not only the net profit but also the owner’s salary and benefits.
SDE multiples vary depending on factors like industry, location, and market conditions. A higher SDE multiple typically implies a higher business valuation, making your business more attractive to potential buyers.
2. Organize Your Finances
Whether you’re the seller, it’s essential to have your financial records in order. This step is crucial to both parties involved in the sale. Key financial documents include:
- Licenses, deeds, and proprietary documents.
- Profit and loss statements for the past three years.
- Tax filings and returns.
- A brief overview of your business or personal finances.
Sellers should remember that some expenses reported as business expenses to the IRS, like travel costs and personal vehicle use, should be added back to earnings when calculating SDE.
3. Evaluate Your Assets
While it may be challenging to assign an exact value to your entire business, you can create a comprehensive list of assets and liabilities. This includes tangible assets like real estate, equipment, inventory, and cash, as well as intangible assets such as patents, copyrights, brand reputation, and customer loyalty.
Liabilities, such as outstanding debt and payables, should also be considered as they affect the overall business value. Sellers often settle their liabilities after selling the business.
4. Research Your Industry
Knowledge of industry trends and market conditions is essential to determine an accurate valuation. Look for comparable businesses (often called “comps”) within your industry to gauge market standards and gain insights into market share and growth potential.
5. Choose the Right Valuation Method
For small business sales, the SDE multiple is often the method of choice. However, there are other valuation methods as well, such as the Asset-Driven approach and the Market Approach. The choice of valuation method may depend on the specific characteristics of the business and the preferences of the buyer and seller.
Conclusion
Valuing your small business when selling is a complex yet essential task. Understanding the key principles, organizing financial records, evaluating assets and liabilities, researching the industry, and choosing the right valuation method are vital steps to ensure a fair and accurate assessment. Whether you’re planning to sell your business, emphasizing the SDE multiple is your roadmap to a successful sale.
