Quick Guide on Small Business Valuation
Valuing a small business is important for reasons such as to gauge future revenue, the current market value of assets and capital structure compositions.
A growing industry typically enhances the valuation of businesses within it. Increased demand suggests the potential for higher future revenues and profits, making companies in booming sectors more attractive to investors.
Business valuations are integral to the profitability of a company. Be it for the company’s internal use or preparations for a sale, these reports act as a quick guide and check on the company’s financial health.
Top Reasons to value your small business
Valuing a small business is important for reasons such as to gauge future revenue, the current market value of assets, capital structure compositions, and many more. Suitable valuation techniques are used to arrive at a near-exact estimation. Let us look at some basic reasons:
- Issuing shares – A periodic valuation is a healthy practice to track and manage stock prices. Based on the company’s current worth in the market, the management can decide to issue new shares, buy back some, increase, or decrease the pricing.
- Buying a business – It is common knowledge that the true value of a business is finally what the buyer agrees to pay. The founder tends to shoot for the moon and the investor prefers the best possible economic return on investments. A reliable small business valuation report ensures that factors such as market forces and potential income are taken into account that helps to arrive at a reliable valuation; one that is fair to both the owner and the investor.
- Selling a Business – If the sale is pre-planned, as in the case of a planned exit or acquisition, more often than not a strategy is in place. But if a founder decides to sell under circumstances beyond a planned acquisition, preparations must start at least 2 years in advance. Small business valuation acts as a reality check for the company.
- Funding – Investors refer to these reports to evaluate the company’s performance and future potential. A good valuation that also promises future growth potential must be backed by a realistic business plan. It is in the best interests of the company to keep a valuation realistic.
How to maximize your small business valuation?
Apart from the valuation methods, founders must consider the following precautionary measures while preparing for a valuation. These factors, when periodically monitored, have a positive impact:
- Hire professional evaluators – Apart from a reliable 409a valuation report, their expertise helps in building new profitable strategies as well. It is in the best interest of a company, especially a small business, to do a periodic valuation as a health check for the business. Any preventive measures required can be acted upon on time.
- Focus on bottom-line – Cash flow is the baseline for valuation. Investors find a company attractive based on its profits, not just high sales. $10 million in sales and $7 million in earnings is much better than $20 million in sales and $7 million in earnings. Thus, a small business must focus on those products and services that bring them the highest profits. Also, a few stable clients with good payment terms are much better than multiple clients with bad credits. A small business must re-strategize to ensure the profitability in advance of valuing the small business
- Minimize Founder’s involvement – Valuation of a business is higher when company management is skilled enough to function independently of its founder. When it is sold, the founder either moves on to other ventures or takes up a strategic role in the new setup. Thus, independent management is an asset and maximizes a small business valuation. It indicates the strength and expertise of the management team of operating with minimum interventions.
- Documentation – A minimum of 5 years’ financial statements must be up-to-date. Based on the purpose of the valuation, some other types of documents such as copies of business licenses, permits, deeds, certifications, live contracts with insurers, creditors, vendors, and clients may also be required. Owners must make a habit of the practice of documentation from the start of the company operations. It minimizes the time and effort of backtracking or worse, missing documentation.
Small Business Valuation Trends
Small business valuations are experiencing notable shifts influenced by various economic factors, market dynamics, and investor behaviors. We listed here the key trends shaping the landscape.
Impact of Private Equity
Private equity firms are significant in business valuations, especially in middle and lower-middle markets. This trend has emerged as larger transactions become less favorable. Smaller deals are viewed as lower risk and more manageable for investors. The availability of capital among private equity firms remains high, with approximately $1.35 trillion in “dry powder,” pushing them to seek out acquisitions even in a tight credit environment.
Shifting Valuation Multiples
Multiples for small businesses are not stable based on several factors including company size, industry conditions, and economic landscape. For example, the selling price to EBITDA ratio for private businesses has decreased from over 8x in 2018 to about 5x in 2023.
This contraction reflects broader market trends and highlights the importance of understanding how size affects valuation—larger companies typically command higher multiples due to perceived stability and growth potential.
Market Demand and Competitive Landscape
High demand for small businesses can elevate valuation multiples as buyers compete for limited opportunities. Industries that have high barriers to entry or fewer competitors tend to see higher. For example, sectors like pharmaceuticals and technology often attract premium valuations due to their competitive advantages and revenue stability.
Economic Influences
Current economic conditions have introduced challenges for business sales. These factors have forced financing options for acquirers, affecting their ability to meet seller expectations. Despite these headwinds, there are signs of a rebound in certain segments; specifically, transactions valued between $5 million and $50 million have seen a slight increase in valuation multiples from 4.8x to 5.3x year-over-year.
Emphasis on Human Capital
Metrics such as customer satisfaction, and training programs are becoming critical indicators of a company’s long-term value. This shift aligns with broader trends towards sustainable and socially responsible business practices
Understanding these trends is essential for business owners looking to navigate the complexities of selling or valuing their companies effectively in the current market environment.
Get Your Small Business Valuation Report from Experts
Small business valuation reports are a cumulative analysis of multiple factors. Though founders always aim for the highest possible valuation, reports must reflect the reality of their industry. Hence, engaging professional business evaluators is advised. They not only provide company 409a valuation reports, but from their expertise of working with multiple companies spanning different industries, they are in a better position to suggest the strategic changes needed to maximize the company valuation.
Our team of valuation experts at Eqvista are among the best suited for this process. We are experienced in closely working with various companies, issuing and managing their cap tables, company shares, and reports. Here is the full range of our expertise.
