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How to Know What Your Business Is Really Worth

Deciding the real value, or Fair Market Value, of a business is truly an art and a science. As with anything being sold the real value is only what a ready, willing, able buyer is willing to pay on the open market.

This being said, as an owner, you are the expert on your operations and you will know it better than anyone else. Often because you know everything about your company, this can cause you to feel that your company is so special that it must be worth more than any other business. And this is what causes many owners to place an artificially high value on their business.

To help you as an owner, understand the fair market value, let’s take a look at how a business is valued by valuation professionals (and lenders).

Businesses are valued based on comparing them to other companies / opportunities of similar size and cost.

The most commonly used factor for valuing a business is based on the seller’s discretionary earnings (SDE) multiplier.

The SDE is based on the profit of the business with factors such as depreciation, interest, amortization and owner’s salary added back to the profit and all the expenses normalized for the business. A professional business broker, valuation expert, or lender will calculate this number.

This number (SDE) is then used to calculate a selling price. The rule of thumb is 1 to 3 times the SDE results in the selling price. Interestly every business owner wants their business to be at the 3 level, but most are around 2 and some lower.

Now, in larger companies, EBITDA (earnings before interest, tax, depreciation and amortization) is used. There is a difference between SDE and EBITDA with the seller’s salary and normalization not included in EBITDA. Therefore where SDE is a factor of 1-3, EBITDA is a factor typically 3-5. Often these numbers are very similar when calculated.

To accurately establish a fair market value, a valuation should be done by a qualified professional. Valuations often cost $2500 – $10,000 or more depending on the business. For many sellers, this provides a peace of mind that they are getting a fair market value for their business.

Selling a business is an emotional decision and the biggest reason a business does not sell is that the business is over priced. So to help you prevent your business from not selling, make sure to have a business valuation done before you try to sell the business.