Valuing a Business

Last night EO Atlanta had an event on positioning a business for sale including how to value it. Typically a business that is bought by an acquirer actively browsing is worth more than when a company shops itself around to other companies. Let’s look at a few more factors in valuing a business:

• Concentration of customers (e.g. one big customer or lots of little customers where more customer variety usually is worth more)
• Gross margins (percent of revenues after only product/service costs are taken out with high gross margins being more valuable)
• Recurring revenue (percent of revenue that comes from monthly or annual fees with higher percentage of recurring revenue being more valuable)
• Profits over the last twelve months (a simple formula for an average company is that the company is worth 4-6x the previous year’s profits)
• Growth rate over the last twelve months (faster growth rate is more valuable)
• Liquidity of the shares (more liquidity like with publicly traded companies is typically much more valuable e.g. 50%+ more valuable)

As you can see there are many different factors in determining the value of a business. It comes down to what another company or person is willing to pay for it with the more profitable and faster growing businesses being more valuable. An example would be a company with $1 million in trailing twelve months revenue with $200,000 in profit (assuming founders and management had market rate salaries) might be valued at 5x the profit, or $1 million. Some companies with no profits are bought for many times revenue due to their strategic value whereas other companies with significant revenues are bought for only a fraction of revenue due to significant debt, losses, and a decline in the business (e.g. Newsweek for $1).

Valuing a business is tough as the market of buyers is usually very small. These guidelines can help you come up with a rough idea of what a business might be worth.