Business Valuation Explained: frequently asked business valuation questions
Does the money that someone invests to start a venture affect the business valuation?
No. If the seller has, for example, spent $200,000 to get a business started, he or she may think the business is worth at least that much. However, standard business valuation methods may indicate the business is worth only, say, $125,000. And that's all the business is going to be worth. The $200,000 spent by the seller to start the business is, sadly, irrelevant to the business's current valuation.
Where can one get information on business valuation rules of thumb?
The best source that I'm aware of for business valuation rules of thumb is a book written and edited by Tom West. The book title uses the year number and the phrase "Business Reference Guide." The 2004 edition of the book, for example, is named, "The 2004 Business Reference Guide." The book is published by Business Brokerage Press. Their telephone number is 1-800-239-5085.
Where can one get information on business valuation discount rates?
Discount rate information isn't readily available--at least in some published format. Essentially, the discount rate used to calculate a discounted cash flow business valuation is the return on investment that an investor thinks he or she should receive. Typically, small business discount rates run from 20% to %30. But sometimes the rates are higher (such as for very risky startup ventures). And sometimes the rates are lower (such as for businesses that own lots of real estate or other hard assets).
You can get statistical databases of businesses that have sold in the past, however. And from these statistical databases, you can deduce appropriate discount rates. One popular statistical database of small businesses that have been sold is called BizComps. You can order a copy of BizComps from the publisher, John Wily & Sons, by ordering from one of the online bookstores, or direct from the author by calling 1-702-454-0072.
How do things like SDCF and EBITDA affect business valuation?
SDCF is an acronym for sellers discretionary cash flow. EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization. For the purposes of small business valuation, these two numbers are essentially equivalent. Both refer to the cash profits of the business. Many of the rules of thumb use SDCF or EBITDA as an input to the rule of thumb calculation. A discounted cash flow business valuation would typically use EBITDA as the cash flow amount being discounted.
One other thing to keep in mind about SDCF and EBITDA is that they treat the amounts paid to an owner for operating the business differently. The business owner is paid out of SDCF. The business owner is paid before EBITDA.
Where can I get more information about business valuation?