If you are thinking about selling your company, it’s time to learn how to value a business. Determining the fair market value of your business is the first step in a successful sale. A business valuation sets a negotiating point with buyers. It also might be required when you are seeking a bank loan. 

There are many factors to consider in determining a business’s sale value. Business owners can use any one of several valuation methods, or a combination, to determine how much money they should seek from a buyer. They also can take advantage of many tools and services — and even calculators. 

In this article, we’ll go through the details of common company valuation methods and look at some issues that are particular to government contracting businesses. We’ll also look at important issues to consider as you try to assess the value of a business.  

Common methods of business valuation   

So, you’re ready to do some math to determine your book value, but where do you start and what method will work best for your business model? We’ll look at the most common business valuation methods in this section.  

While some methods focus on business assets, others are based on revenue or profit or comparing the value of your business to comparable companies in the market.  

Discounted cash flow   

Cited as the gold standard for business valuation by many experts, discounted cash flow analysis is a method in which you estimate the value of a company based on cash flows, or money, expected in future growth or future earnings. It’s a more complex model that calculates the present value of expected future cash flows based on the discount rate and time period of the analysis.  

This approach works best for newer businesses — or small businesses — with high-growth potential that aren’t yet profitable. Using a discounted cash flow analysis reflects your business’s ability to generate cash. The downside is that this valuation method requires compiling a great deal of data and its accuracy depends on the estimates made about future activity.   

Profit multiplier method   

The profit multiplier method is straightforward and is used if you’re hoping to value your business based on specific figures like revenue and sales. This method is considered to be a rule of thumb method, or a useful approximation.   

To start, you’ll need two figures: the annual net income or profit earned by the business and the multiplier that is commonly applied for businesses in the same industry.  

For the net income or profit, use an average annual figure. If a business owner uses the figure for the most recent year, that could give an inaccurate picture. Maybe that year was slower or busier than usual. A five-year average gives a more accurate picture. If you think the company is poised for much larger growth, you must factor that into the sale another way.  

Valuing a business based on profit works well because it can easily illustrate how much income a prospective owner can earn from running your business. It is why companies are often priced based on their profits (or bottom line).   

This method uses past performance to predict future outcomes and a multiplier generalized for an industry. The negotiations typically involve adjusting and readjusting based on the individual business.  

Book value   

Using book value is one of the simplest methods for determining fair market. This valuation method estimates a company’s value using information from its balance sheet, as opposed to market capitalization, another simple method for determining value. (In that method, the value of a public company equals the total number of outstanding shares multiplied by the price of the shares.)   

To find a business’s book value, subtract the company’s liabilities from its assets to determine owners’ equity. Then, exclude any intangible assets. The resulting figure represents the value of any tangible assets the company owns.  

Because of the simplicity of the method, it can be unreliable because it doesn’t always completely reflect a business’s total or potential value.  

Market comparison   

It can be challenging to perform a true market comparison valuation, but it’s generally understood and accepted by all parties because of its “user friendly” nature.  

Think of this method as the business equivalent of residential real estate values and the importance of using comparable houses recently sold to derive costs per square foot. What you’ll need to find is a similar company that has recently been sold. You also will need to find enough information about its value and the terms of the sale to draw a comparison to your business.   

If you’re working with a business broker who has recent experience with companies like yours, they will be able to help you determine the potential value of your business compared to recent sales. If you’re working with an appraiser, it’s important that they use reputable databases (like DealStats or Bizcomps) to determine market value.   

Government contracting businesses   

Businesses that deal in government contracts are valued by considering several key characteristics, including financial performance, growth, contracts, customer relationships, management and human resources, and lastly, market differentiators.   

While some of those characteristics are obvious, others are a bit more involved and can have different impacts on your business value. When it comes to contracts, for example, there are some restrictions on 8(a) and small business set-aside contracts. If a small business were to be acquired and grow past its “small” size, the contracting agency would no longer get credit for contracting with that small business. Limitations on 8(a) contracts are similar for an acquiring company. Both of these limitations can reduce the value of a company for the buyer because it might not be able to fulfill the outstanding contracts.   

Generally speaking, buyers like diversification of customers and contracts. Too much concentration in either category could negatively impact business value. In rare circumstances, a buyer may be looking for a particularly strong relationship with an agency, so concentration wouldn’t negatively affect value.   

Other qualities, like holding more prime contracts than subcontracts, can boost your value because the prime contractor generally has a stronger relationship with an agency. Prime contract holders also tend to have a higher probability of contract renewal and expansion.  

Security clearances can also be valuable, such as top security and high-level Q clearance. Similarly, technical talent is also a highly valued asset.   

Other business valuation factors   

When you begin to determine your company’s value, it’s a good idea to try multiple common methods to paint a fuller picture of what your present value is. Doing so will give you a head start in preparing any sale negotiations, and you’ll also be able to easily identify any weak links or more valuable selling qualities your business has.  

How to use SDE   

One calculation you can do on your own – and absolutely should – is SDE, or seller’s discretionary earnings. This valuation is used to determine the true value of a business for a new owner. It includes information like income reported to the Internal Revenue Service and non-cash expenses.   

Owner-operated companies with annual revenue of around $5 million or less typically use this valuation method.  

To calculate your company’s SDE, you start with your pretax, pre-interest earnings. Next, add purchases that aren’t considered essential to operations but rather benefited the owner. These include vehicles and travel – things that can be reported as business expenses. Include one-time purchases, your own salary, charitable donations and employee outings. Then, all current debts and future payments (or liabilities) are subtracted from the net income.   

Finally, a multiplier is applied to the SDE, to better reflect the value of the business. Multipliers are based on the size of the business, longevity, type of industry and other factors. The multiplier would reflect, for example, whether companies with the same SDE are in industries with positive outlooks (smart phones) or negative ones (beepers). 

A small to mid-sized business in good shape will tend to have a multiplier of 1 to 3. So, the asking price for the business might be SDE times 2.5.  

Online calculators   

Online calculators can be a big help in your valuation determination. Here are a few options: 

• CalcXML: This calculator uses your business’s current and expected earnings to determine a value. It can also consider risk and marketability.  
• EquityNet: This calculator allows you to employ many factors, like estimated profits or losses, future earnings, assets and liabilities, industry, and business survival odds.  
• ExitAdviser: This valuation uses discounted cash flows to determine value.   

Get credentialed help    

If the task at hand still feels a bit daunting, it might be worthwhile to get professional, qualified assistance. Let’s look at a couple of possibilities.  

• Business broker: A knowledgeable broker can help in ways that go beyond determining your company’s value. They also will reach out to potential buyers, screen buyers for viability and present your company in a way that maximizes its selling price and potential.   
• Appraiser: An appraiser can help you evaluate some of the more technical aspects of your business. Sometimes the IRS or SBA require the use of an appraiser. If your business is focused in technology, has high expenditures in research and development, has a good deal of intellectual property or offers a unique product or service, an appraiser can better determine your value. It’s important to look for any of the following designations when seeking an appraiser:  
  • CBA (Certified Business Appraiser), from the Institute of Business Appraisers 
  • ASA (Accredited Senior Appraiser for business valuation), from the American Society of Appraisers 
  • CPA/ABV (Certified Public Accountant/Accredited in Business Valuation), from the American Institute of Certified Public Accountants 
  • CPA/CVA (Certified Public Accountant/Certified Valuation Analyst), from the National Association of Certified Valuators and Analysts 
  • AVA (Accredited Valuation Analyst), also from the National Association of Certified Valuators and Analysts 

Conclusion  

Determining the value of your business can be tricky, especially if it deals in government contracts. The experts at GovCon Wealth, a division of Cope Corrales, make it their business to help others sell their businesses.