Find Out How to Value a Business to Sell with SOT Business Brokers Perth

If you are considering selling your company, you have likely started to wonder ‘how much is my company worth?’. And, is the valuation process different when determining how to value a small business to sell? The discounted cash flow valuation is still the most common methodology used when determining how to value a business to sell. This holds true for big business, small business and even tech start-ups.

The discounted cash flow valuation model uses core principles of economics and finance, even where the inputs to the model may heavily rely on assumptions. In reading a Buffet essay it was he who likened Aesop’s principle that a bird in the hand is worth two in the bush to one of the earliest business valuation models recorded. He is of course referring to the fact that future cash flows are often subject to a variety of dependencies that may or may not come to fruition. But to work out what the bird in the hand is worth, we must look at all the inputs to the valuation model.

You will often hear of talk of ‘multiples of earnings’ in discussions around how to value a business to sell, which is just a derivation of the discounted cash flow model. A buyer wants to know how long it will take them to recover their investment and what return they expect based on the risk they are taking.

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How to Value Your Business - a Buyer's Perspective

Let’s now turn to a basic valuation of a business and look from a buyers perspective. Let’s say our Buyer has $1m to spend on a business. Inputs to our Buyers model:

  • They presently earn a wage of $100k (opportunity cost)
  • They can get a business loan for half of the purchase price with a 7% interest rate.
  • The rate of company tax in Australia is 27.5% for business’ with a turnover under $50m.
  • Our buyer feels that an appropriate risk / reward ratio is 25% per annum to purchase the business.
  • Our Buyer is conservative, so they assume there are only 5% growth prospects in the business.
  • Inflation is 2%

Our buyer wants their money back out of the business after 5 years, so what sort of minimum free cash flow should our Buyer be looking for?
Discounting the $1m back using the above inputs would come back to $268k free cash flow in year one. An example of a business that can produce this sort of profit is set out below:

*Note, it is assumed that since capital expenditure is static its is deductible against taxable earnings in a low value pool or depreciation.

When applying a discounted cash flow model back to the above business we come back to a valuation of $1m as shown below:

A lot of discussion is held on the multiples of EBITDA (Earnings before interest, tax, Depreciation and Amortisation) as a valuation methodology.

In our example the valuation multiple of EBITDA would be 2.2 times. Generally we are seeing multiples of EBITDA being paid on businesses of between the 1.5 to 3 times. But as can be seen from this example, there is more to the valuation than a simple multiple.

So, How Much Can I Sell My Business For?

If you are ready to take the next step and find out how much should you sell your business for, get in touch with the team at SOT Business Brokers. Our highly experienced business brokers will start with a thorough analysis of your most recent P&Ls to determine how to calculate your company's worth. Of course, a credible valuation of your business is just the beginning. To find out more about the steps to selling a business or for a 100% FREE valuation, get in touch today.

About SOT

SOT are Business Advisory and Business Brokering experts. The Directors of the company have built businesses, bought and sold businesses and listed businesses on the ASX. They are now providing these services to businesses who need assistance in getting to the next level of growth, business owners who are thinking about selling their business and buyers who are looking for a business.