7 Business Valuation Methods You Should Know

A reliable business valuation is essential whether you're considering buying or selling a company, attracting investors, or negotiating a loan. However, with numerous valuation methods available, choosing the right one can feel overwhelming.

This article explains seven of the most common business valuation methods, diving into their core principles, strengths, and weaknesses. We'll also provide a helpful tool you can use to streamline the valuation and selling or buying business process. 

Why business valuation matters

Imagine buying a used car without knowing its market value. You might end up paying significantly more than it's worth. Business valuation operates similarly. It objectively assesses a company's financial health and future earning potential. This information empowers informed decision-making for all parties in scenarios like:

• Mergers and acquisitions (M&A), where buyers and sellers need a benchmark to negotiate a fair price during the transaction.
• Estate Planning, where business valuation ensures the fair distribution of a business among heirs. 
• Securing funding, where businesses seeking investment or loans require a valuation to demonstrate their viability and potential for return. 
• Internal decision-making, as it helps business owners understand their company's worth and make strategic decisions like expansion or restructuring.

Related: How Much Is My Website Worth? Tools & Methods to Valuate A Site

7 business valuation methods explained

The choice of a valuation method depends on various factors, including the company's size, industry, financial data availability, and the purpose of the valuation. Here's a breakdown of seven methods you can use. 

1. Market approach

This method compares the subject company to similar businesses recently sold in the same industry. It analyzes factors like size, profitability, and growth potential.

Strengths: Easy to understand and implement if comparable companies exist.

Weaknesses: It relies on the availability of relevant market data and may not be suitable for unique businesses or niche industries, like ecommerce or SaaS. 

2. Income approach

This approach estimates the present value of the company's future cash flows. It considers factors like historical earnings, projected growth, and the discount rate (which reflects the risk associated with the business). There are two main variations within this approach:

• Discounted Cash Flow (DCF): This method explicitly forecasts future cash flows and discounts them to their present value.
• Capitalization of Earnings: This method divides the company's average earnings by a capitalization rate to get the business value.

Strengths: Considers the company's future earning potential, making it valuable for growing businesses.

Weaknesses: Requires accurate financial forecasting and selecting the appropriate discount rate. It can be complex and sensitive to assumptions about future performance.

3. Asset-based approach

This method values the business based on the fair market value of its assets, including tangible assets and intangible assets.

Strengths: Useful for companies with significant physical assets or strong intellectual property.

Weaknesses: May not fully capture the value of a company's earning potential or brand reputation.

4. Transaction multiples approach

This method uses industry-specific valuation multiples based on recent M&A deals in the same industry. Common multiples include Price-to-Earnings (P/E) ratio, Enterprise Value-to-EBITDA (EV/EBITDA) ratio, and Price-to-Sales (P/S) ratio.

Strengths: Relatively simple and quick to apply, especially if relevant industry data is readily available.

Weaknesses: It relies on the assumption that the subject company is similar to those used in the multiples calculation, which may not accurately reflect the business's unique circumstances.

5. Scorecard approach

This method assigns scores to various qualitative factors impacting the business value, such as management experience, market position, brand recognition, and customer base. These scores are then weighted and combined to arrive at a final valuation.

Strengths: Considers qualitative factors often overlooked in other methods.

Weaknesses: It is subjective and highly dependent on the chosen scoring criteria and assigned weights. It requires significant judgment from the appraiser.

6. Liquidation approach

This method estimates the value of a company by assuming its assets are sold off piecemeal. It's typically used for businesses in distress or considering shutting down.

Strengths: Useful for understanding the company's net asset value in a worst-case scenario.

Weaknesses: It may not reflect a business's value as a going concern, particularly if its value lies in its ongoing operations and future potential.

7. Hybrid valuation

Many businesses employ a hybrid approach combining elements from several methods discussed above. This allows for a more comprehensive and nuanced valuation, considering both quantitative and qualitative factors.

Strengths:

• More comprehensive: by combining multiple methods, a hybrid approach provides a more well-rounded picture of the business's value, taking into account both financial data and qualitative factors.
• Reduced bias: reliance on a single method can lead to bias. A hybrid approach mitigates this by incorporating insights from various valuation perspectives.
• Increased credibility: When different valuation methods yield similar results, it strengthens the overall credibility of the final valuation estimate.

What is the Rule of Thumb for valuing a business?

The Rule of Thumb (ROT) gives a rough estimate based on easily available metrics like revenue or earnings. You apply a multiplier to a financial measure of the business, like annual sales, discretionary earnings (cash available to the owner), or EBITDA.

You might be thinking that it sounds familiar, as people often confuse this method with the transaction multiples method. Both of them are related concepts in business valuation, but they're not exactly the same. 

The key differences are the specificity, as transaction multiples are based on real transactions, while rules of thumb are more generic; the accuracy, as transaction multiples can be more accurate for a specific company, while rules of thumb provide a starting point; and flexibility, as rules of thumb can be adjusted based on the company's unique characteristics, whereas transaction multiples are tied to past deals.

How much does it cost to get a business valuation?

It depends. There are two main categories of factors that influence business valuation costs: business complexity and valuation purpose.

1. Business Complexity

• Businesses with clean, well-organized financial statements are easier to value, leading to lower costs. Conversely, messy or incomplete financials will require more work from the appraiser, increasing the cost.
• Some industries have more standardized valuation methods, while others require specialized knowledge or data analysis. A unique or niche industry might demand more expertise, driving the price up.
• Larger businesses with multiple locations or subsidiaries are naturally more complex to value compared to a small, single-location operation.
• Businesses with significant intellectual property, brand recognition, or customer lists require additional valuation considerations for these intangible assets, adding to the complexity and cost.

Read: Will business analysts be replaced by AI?

2. Valuation Purpose

• Reason for valuation: Are you looking for a general idea of value for personal reasons, or do you need a formal valuation for a legal proceeding like a partnership buyout? More formal valuations with legal implications typically require a more rigorous process and cost more.
• Valuation methodology: Different valuation methods are used for different business types and situations. Complex methods requiring in-depth financial modeling or market research will be more expensive than simpler methods based on multiples of revenue or EBITDA.
• Appraiser qualifications: The experience and credentials of the appraiser you choose will also impact the cost. A highly qualified appraiser with a proven track record in your industry will likely command a higher fee than a less experienced professional.

By considering these factors, you can get a better idea of the range you might expect to pay for a business valuation. Valuation costs can go from $2,500 up to $40,000, or even more.

How to choose the right valuation method?

Choosing the right valuation method for your business depends on several factors. Consider the purpose of the valuation, the type of business, and the available financial data. If your company is mature with steady financials, a market-based approach comparing it to similar sales might be relevant. Early-stage businesses might benefit more from a future-oriented method based on growth potential.

Consulting a professional valuation expert can help you navigate these factors and ensure you choose the most appropriate method for your specific situation.

Get business valuation advice from Boopos

Boopos can help you navigate this complex topic. It is a simple yet very useful and accurate partner that will give you the valuation you need without having to spend a dime. Get insights on the value of your business now!