Small business valuation is a lot like street magic:
- There isn't much information about it online
- You don't know what to expect
- It's hard to tell who's a professional and who's a phony
The big difference? Instead of getting a playing card with your cousin's birthdate on it, you get an invoice for $10,000 with your name on it.
In this article, we break down the different ways to value your business and show you what's real and what's fake.
Keep in mind, there are different techniques when it comes to valuing a business (market-based, discounted cash flow, asset-based, etc.) - but that's a whole other can of worms. The focus of this article is the different types of services available to you as a business owner.
Should you pay for a $10,000 valuation of your business? Well, like wearing denim on denim, there's a time and a place. Here are a few reasons you should pay $10,000+ for a valuation:
- You need your valuation to stand up in court (divorce, court settlement, corporate lawsuit, etc.).
- You are completing an internal valuation (for tax purposes) for review by the CRA or IRS.
In Canada, Certified Business Valuators (CBV) complete these valuations, which usually exceed $10,000. But if you don't need a legally defensible valuation, this is a steep price to pay. Especially if you are only trying to keep track of your business's value.
Verdict: Real (but look for the correct designation)
Rule of Thumb Valuations
A rule of thumb valuation usually happens as per the following sequence:
- Sally is the owner of Sally's Bookkeeping and is thinking about selling. So Sally talks to Jane who sold her bookkeeping practice a few years ago. When Sally asks about business valuation Jane replies, "I was told that bookkeeping practices sell for 80% of revenues." Thinking this sounds reasonable, Sally uses that figure to calculate her asking price.
There are a few problems with this approach:
- You have no idea if this is advice is accurate or not
- It doesn't account for the nuance of your business vs. others. For example, let's say there are 2 bookkeeping practices both making $500,000 in revenue. Of the 2 practices, 1 is profitable and the other loses money. But if we apply Jane's rule of thumb valuation, both of these practices are worth the same amount.
This is not to say that rule of thumb valuations aren't valid. But they require verification and comparison to other valuation approaches.
Verdict: Often inaccurate
Your final option is using self-directed business valuation software such as PriceBuilder. This option requires the most work but is the best compromise between cost and accuracy.
PriceBuilder, for example, is $20/month but uses the same valuation methodology of the International Business Brokerage Association (IBBA). The result is an accurate business valuation for only $20 and 30 minutes of work.
The problem with self-directed software? It can't tell if you're lying about your numbers. This means the software will only be as accurate as the information entered.
Verdict: Real (if you don't cheat)
What business owners get wrong about valuation
Whichever option you pick, make sure to avoid these mistakes:
- Picking the option based on what gives you the highest valuation. While tempting, don't just pick the option that gives you the highest price. For one, buyers won't be as generous. Two, this sets false expectations for when you do plan on selling. Be extra cautious if the 'rule of thumb' valuation is much higher than other approaches.
- Thinking your valuation is fixed forever. We always say that you can't grow something that you can't measure. Calculating your valuation is the first step, the real work is improving your business to grow that number. Try to not get disappointed or discouraged by a lower-than-expected business valuation. Rest assured it is one of the few numbers you control (most of the time). Imagine if a realtor told you that if you painted your house your listing price would increase $60,000 - would you do it? Well, this is exactly the same situation for many businesses. But rather than a new coat of paint, you may need to upgrade your POS system, hire another technician, or clean up your books.
Interested in increasing your business valuation? Join our PriceBuilder Community and start building a better business today.