How is a business valued?


How is a business valued?

The first step towards determining the value of a business is calculating a Seller’s Discretionary Earning’s (SDE) number.  Please refer to the following post on determining SDE:

Once we have an SDE number we are now ready to complete the valuation by using a multiplier.  The typical business value multiplier in Tucson is between 1 and 3.  For instance if a company has a SDE of $100,000, the business would be worth $100,000 based on a 1x multiple or $300,000 on a 3x multiple.  The difference in business value can be rather significant based upon the multiple placed upon it.

The next question logically becomes:  How is the multiplier for a business determined?

There are several variables which must be weighed when determining a realistic multiplier.  Some of the  important variables tend to be size of the business, owner’s responsibilities, industry, and revenue/profitability trend.

Size of the Business – Larger Businesses receive larger multiples.  With larger businesses come larger revenues and typically larger profits.  Bigger businesses also have the luxury of taking on additional overhead to reduce owner’s responsibilities.  Bigger enterprises also tend to have larger asset bases which discourage competition.

Owner’s Responsibilities – The more involved the owner is in the day to day operations the lower the multiple.  The pool of buyer looking for absentee and semi-absentee buyers is quite large, and willing to pay a premium, thus rewarding the business owner with a higher multiple.  A business has more value if an owner works 5 hours a week versus 70 hours a week.

Industry –Some industries are dying while others a growing, this is just a fact of business.  How disruptive is technology to the business being sold?  Have newer, larger, better capitalized players moved into the industry, is the business competing with Amazon?

Revenue/Profitability Trend – Businesses that are in decline receive lower multiples.  Businesses that are trending up receive higher multiples.

Now let’s look at a practical real-world example, we have Joe’s Auto #1 and Joe’s Auto #2.

Joe’s Auto #1 is run by Joe.  Joe’s typical day involves opening the shop at 6am, greeting customers, checking in their vehicles, selling repair services to customers, ordering parts, helping fix the cars, getting customers checked out, closing up the shop then doing administrative work.  Joe has one employee who handles some basic mechanical skills and his wife comes in to help when she can.  Joe’s Auto #1 does $250,000 in annual revenue with SDE at $80,000.

Joe’s Auto #2 is owned by Joe.  Joe’s typical day involves coming in around 9 and begins with an update on the day’s activities by the service and parts manager.  Joe’s Auto #2 has 11 employees who handle the day to day business functions.  Joe then spends the next few hours supporting his managerial staff