“Business Value” is defined as the sum of all operating assets necessary to derive the company revenue including fixed assets and all intangible assets related to the production of income and cash flow streams. Knowing your business range of value is a vital component of success that can make your operation more efficient and more profitable. Once business owners understand their market valuation, they can plan better and create a more durable infrastructure. The SMP Capital Partners team believes that every business owner should always have a current business valuation handy and understand how it works.
How it Works
Initially, SMP Capital Partners team provides a complimentary valuation for transactional purposes that outlines your current range of value. This is based on careful analysis of your company’s historical and year-to-date financial data, current and thoroughly researched comparable industry sales, and commonly held industry standard metrics that influence business value. These metrics include indicators and benchmarks that include infrastructure and org chart strength, customer concentration, owner role, long-term growth potential, and more.
Why Business Valuation Matters
Knowing your business’ range of value can help facilitate clear forecasts & projections while generating a stronger, more transparent and resilient infrastructure. Regular business valuations should be as routine as counting inventory, quarterly reporting, payroll analysis, budget forecasting, tax preparation, and performance reviews. Adding an annual business valuation update to your routine business health checkup supports succession planning and improves value drivers. It optimizes performance, improves process efficiencies, strengthens your value proposition, solidifies client loyalty, generates new market opportunities, creates intense focus on target markets, improves org chart performance, and builds out long term planning strategy.
The Income Approach
When it is time to take your business to market, a current valuation is the critical component of a successful transaction, and you will need current and accurate financial and accounting data readily available for review. The income (cash flow) approach to business valuation examines a business based on its cash flow earnings over a set period of time. Valuation experts examine future net cash flow projections, typically for 5 years, and add a terminal value to capture everything beyond that 5-year time horizon.
Those future net cash flows are discounted via a built-up discount rate that incorporates several layers, starting with the risk-free rate and ending with a company-specific risk premium. The resulting discount rate is applied to the 5 years of projected cash flow, along with a discount applied to the terminal value. Combined, those create an accurate assessment of present value of the future cash flows of the business and the total Enterprise value.
- Projects future cash flows over 3 to 5 years, discounts back to present value
- Requires assumptions on revenue growth, margins, capex, working capital
- Discount rate reflects business risk and buyer return expectations
- Sensitive to assumptions as small changes produce meaningfully different results
- Best for businesses with reliable history and predictable cash flow
The Market Approach
Comparable Analysis
Comparable analytics examine recently closed business transactions through a variety of valuation metrics that construct real world comparisons to businesses that have actually sold. This approach identifies a valuation multiple from comparable transactions and applies it to a normalized earnings metric from the business in question. The most common criterion in lower middle market valuations is EBITDA (Earnings Before Interest Taxes Depreciation & Amortization) and SDE (Seller’s Discretionary Earnings) for small market businesses.
The multiple applied to normalized earnings comes from several different sources that compile actual closed private company transactions by deal size, revenue, EBITDA, SDE, and implied multiples. After normalized earnings are verified, which is critical to establishing Enterprise Value, they are applied to a multiple. The multiple requires nuanced judgment and experience. Professional valuation experts like the team at SMP Capital Partners consider business size, historical growth rate, margin performance, customer concentration in addition to a vast array of other factors.
- Most common approach for privately held businesses with consistent earnings
- Values a business by comparing it to similar businesses that recently sold
- Same logic as real estate comparables
- Analyzes closed transactions of similar businesses in same or related industries
- Uses multiples: EV/EBITDA, EV/Revenue, Price/SDE
- Data derived from private transaction databases, industry reports, & actual advisor deal experience
- Must adjust for size, geography, growth, customer concentration, profitability
- Most persuasive method for sellers because it reflects what buyers actually paid
Industry Standards
Any business that is experienced sustained long term success has innovated, edited, transformed, and shifted focus many times. Yet there is a universal constant amongst them all. What do all businesses who have achieved long term sustainable success have in common?
Every industry of the global economy employs a series of structural guidelines which establish a standard expectation of business operations, compliance, consistency, and a baseline set of performance metrics. Industry standard guidelines and specifications established by industry veterans provide the minimum criterion for measuring and managing business operations. Years and decades of trial and error, innovative ideas, and economic fluctuations across all industries establish a set of best practices related to production and business development.
This approach provides a third check to the valuation process and guarantees a balanced approach. While there are no precise benchmarks there are numerous prescribed databases that accumulate information as guideposts and combine data for a NAICS code and provide summaries of industry standard multiples by several metrics including company size, geography, historical growth, customer concentration, and profitability.
- Floor value of a business. Rarely the primary method for an ongoing concern
- Can be relevant in distressed scenarios or wind down situations
- Buyers sometimes reference as a negotiation anchor even for healthy businesses
- Useful as secondary reference point or ceiling indicator
Method Application
- Most valuation experts consider two or more approaches and reconcile results
- Income approach typically carries the most weight for operating businesses
- Market approach provides a reality check based on current buyer behavior
- Industry standards approach sets the floor and acts as a standardized check to balance the range of value
- Final opinion presents a range of value rather than a singular target appraisal
- In a live process, competitive buyer engagement ultimately sets the price
Which Method Is Right for Your Business?
- Service businesses with light assets and strong cash flow: income and market approaches
- Manufacturing, construction, equipment heavy: blend of all three
- Early stage or high growth: modified income approach accounting for future potential
- Significant real estate holdings: separate valuations for operations and property
- Valuation methodology implementation depends on business type, valuation purpose, and audience
Know Your Value — No Cost, Just Clarity
The team at SMP Capital Partners believes that every business owner should always know their business value. Knowing your business value is the key to better planning, smarter decisions, and stronger infrastructure. And here is the best part – it is completely complimentary.
Let us start the conversation together. If you do not know what your business is worth today, we would love to show you. No risk, no obligation, just powerful insights that will make your business stronger.
SMP Capital Partners offers investment banking services to privately held businesses and business owners. The experienced team successfully bridges the gap between main street SBA business brokerage companies with limited access to M&A and non-government underwritten capital markets, and the institutional investment banking firms who acquire businesses in the middle market. We deliver efficient, trustworthy, and expert M&A services to businesses in the small and lower middle markets up to $150m+ in enterprise value. With over 50 years of deep learned, real world deal experience, we understand the mechanics and nuance of deal management and how to successfully navigate transactions from start to finish.
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