If you need a bullet-proof way to show what your business is worth, compare it to similar businesses that sold recently. In fact, such business market value comparisons are widely used by business people and professional business appraisers. So much so, that they deserve an official name: Comparative Transaction business valuation method.
Market comps and business fair market value
One of the greatest strengths of valuing a business by the Comparative Transaction method is that it establishes the business fair market value. This is perhaps the best known standard of business value.
Done correctly, such business valuation results are compelling and defensible. Many business people believe that the market ultimately decides what businesses and their assets are worth.
Business valuation mechanics: pricing multiples
To make an apples-to-apples comparison, you can use a number of pricing multiples – ratios which relate the likely business selling price to its financial performance. Examples of commonly used business pricing multiples are:
- Business selling price to discretionary cash flow or net cash flow.
- Business selling price to gross or net revenue.
- Business selling price to net income, EBITDA, EBIT, EBT.
- Price to total assets, tangible assets or business book value.
To make the comparison accurate, you can pick a number of actual business sales in a specific industry. Some questions that come up often:
1. My business generates income from several profit centers. How do I do my business market value comparisons?
2. My business is very specialized. Are there enough similar business sales to compare against?
Business market value comparisons, such as those offered in ValuAdder Market Comps are organized by industry. If your business is pure play, deriving all or most of its income from one industry, you can make your business value comparison directly against your industry group.
For multiple profit center businesses, you can estimate your business fair market value as follows:
- Check the business values in each industry group of interest.
- Assign a weight to the business market value result from each industry in proportion to its revenue contribution to your business.
- Sum up the results to get a business value estimate for your company.
We are looking at a business with $1,000,000 annual sales.
Let’s assume that the business generates 70% of its revenues from retail product sales. The remaining 30% are derived from its client consulting services.
We check comparable business sales using the pricing multiples for retail sales and consulting services. The first comparison uses the $700,000 revenue as the basis and indicates that this part of the business is worth around $550,000.
The second comparison, using the $300,000 revenue basis, shows an additional business value of $250,000.
Combining the two results, we get the business market value estimate of $800,000.
Note that this estimate does not account for the synergies among the business profit centers. That is why it is a good idea to value your business several ways – including the income-based business valuation methods such as Discounted Cash Flow and Multiple of Discretionary Earnings.
Fair market value estimation for specialized businesses
If your business is very specialized, chances are there are not enough comparable business sales. In this case, you can choose a broader industry group to do your business value comparison.
Standard industrial classification systems, such as SIC and NAICS, are very helpful to locate the relevant industry groups.