If you’ve been running your family business for over a decade, it might be time to assess its value. Whether you’re thinking about succession planning, selling, or just gaining a clearer picture of your financial health, understanding your business’s value is essential. But with so many valuation methods available, how do you choose the right one?
In this guide, we’ll walk you through the most common business valuation methods, provide detailed comparisons, and explain which is the best fit for small, long-established businesses like yours.
Why You Should Consider Valuing Your Family Business
Valuing your family business is not just a step to take when selling; it’s a strategic tool that can help you:
- Understand your business’s market position.
- Identify areas for growth and improvement.
- Plan for retirement, succession, or investment.
For a family business that has been operating for more than 10 years, this process can uncover financial trends, strengths, and weaknesses that may have gone unnoticed.
The Main Business Valuation Methods
Valuing your family business is not just a step to take when selling; it’s a strategic tool that can help you:
1 - Asset-Based Valuation
What is it?
An asset-based valuation looks at the total value of your business’s assets and subtracts its liabilities. This method is best suited for businesses with substantial tangible assets like real estate, equipment, or inventory.
Types of Asset-Based Valuations:
– Going Concern Method: This approach assumes the business will continue operating, and the assets are valued at their book value (purchase price minus depreciation).
– Liquidation Value Method: This assumes the business will be sold off or closed, and assets are valued at their “fire sale” price, or what they would sell for quickly.
Example:
Let’s say your family business owns a building worth $500,000, machinery worth $200,000, and has $100,000 in outstanding liabilities. Using the going concern method, your business might be valued at $600,000 ($700,000 in assets – $100,000 in liabilities). If you’re using the liquidation method, the building might only fetch $400,000 in a quick sale, dropping the total valuation.
Best for:
– Businesses with significant tangible assets.
– Manufacturing, construction, or retail companies.
Not ideal for:
– Service-based or tech companies, where intangible assets (like intellectual property or goodwill) hold more value.
2. Income-Based Valuation (Profit-Based)
What is it?
The income-based approach, often referred to as the **earnings valuation**, focuses on your business’s ability to generate profits in the future. This is one of the most common methods used for small businesses, especially those with a steady history of earnings.
Types of Income-Based Valuations:
– Capitalisation of Earnings Method: This method looks at your current profit and divides it by a capitalisation rate (a percentage based on the risk of the business). Essentially, it calculates the current value of your future earnings.
– Discounted Cash Flow (DCF) Method: This projects future cash flows over a set number of years and then “discounts” them back to present value using a discount rate, often based on the business’s risk and industry.
Example:
Your family business has a net annual profit of $200,000. Using the capitalisation of earnings method with a capitalisation rate of 20%, the business might be valued at $1 million ($200,000 ÷ 20%). If you use the discounted cash flow method, you might project cash flows of $250,000 for the next five years and then discount them based on an interest rate or risk factor, giving you a more nuanced value.
Best for:
– Profitable businesses with steady cash flow.
– Businesses with over 10 years of financial history.
Not ideal for:
– Companies with highly irregular earnings or unpredictable cash flow.
3. Market-Based Valuation
What is it?
A market-based valuation compares your business to similar companies that have recently been sold. Essentially, the value is derived from the “market” by finding out what other, comparable businesses are worth.
Methods within Market-Based Valuation:
– Comparable Transactions Method: Looks at similar businesses sold recently and uses their sales prices as a benchmark.
– Industry Multiples Method: Uses a multiple of your business’s earnings (usually EBITDA or net income) based on industry standards.
Example:
If similar family-owned retail stores in your area have sold for 3x their EBITDA, and your business has an EBITDA of $300,000, your business could be valued at $900,000. You can also look at transactions in your region, especially if there’s data available on local businesses like yours.
Best for:
– Businesses in well-established industries with plenty of comparable sales data.
– Small businesses in sectors like retail, hospitality, and services.
Not ideal for:
– Highly niche businesses with few comparable sales.
4. Multiple of Discretionary Earnings
What is it?
This method is a variation of the income-based approach, specifically designed for small businesses. It adjusts earnings based on the owner’s personal financial benefits, like salaries and perks that wouldn’t continue after a sale. These adjusted earnings are then multiplied by an industry factor.
Example:
If the owner takes a large salary or includes personal expenses in the business’s accounts, you would adjust the earnings to reflect a more accurate profit. Say your business makes $150,000 in profit, but once you add back the owner’s salary and perks, the “discretionary earnings” rise to $250,000. If similar businesses sell for 2.5x discretionary earnings, your business might be valued at $625,000.
Best for:
– Owner-operated small businesses.
– Businesses where the owner’s compensation heavily affects profit.
Not ideal for:
– Larger businesses with multiple shareholders and less personal involvement from the owner.
Which Valuation Method is Best for Long-Established Small Businesses?
For a family business that has been operating for over 10 years and has never done a formal valuation, the income-based valuation is often the most suitable method. This approach:
- Focuses on your business's profit-generating potential.
- Works well for businesses with a steady history of earnings.
- Can give a more accurate reflection of the long-term value of your company.
However, depending on your industry and the specific assets your business holds, a combination of income-based and asset-based methods may provide a clearer, more holistic view of your business’s value.
Conclusion
Valuing your family business is a crucial step toward understanding its true worth. Whether you’re looking to sell, pass it down to the next generation, or simply gain a clearer financial picture, choosing the right valuation method ensures you’re making informed decisions.
For businesses with over 10 years of operation, the income-based method is often the best fit. However, incorporating elements from other methods (like asset-based or market-based) can provide a more comprehensive view. If you’re unsure which method suits your needs, consulting with a business expert can help guide you through this complex process.
At Venture.ly, we specialise in helping long-established businesses understand their value and prepare for the next chapter—whether it’s selling your business, finding the right investor, or preparing a succession plan to safeguard your business legacy.
Contact us to learn more about how we can support your journey!