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	Tom Severance Author of Business Start-Up Guide
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	Steven D. Strauss Author of The Small Business Bible
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Business Valuation

The three generally accepted methods of valuation are:

Balance Sheet Method: Assets minus liabilities give a value to the business. Variations include pure book value (historic cost), adjusted book value (fair market value), and liquidation value (immediate sale).
Income Statement Method: Capitalize earnings or sales with a chosen capitalization rate. Make decisions on what years to average for earnings or sales, what adjustments to make to earnings (taxes, interest, depreciation, owner compensation), and what growth and capitalization rates to use.
Discounted Cash Flow: Project cash flow of the business into the future, choosing an appropriate discount rate, and discounting the cash flows back to today’s present value.

You need accurate data from the seller to perform a proper analysis. You may want to hire an accountant or a specialized business appraiser to perform a detailed analysis. However, use the following suggestions to obtain an approximate value.

Use the liquidation value as the floor or low end of what a business is worth. Use the adjusted book value based on fair market value of assets as a quick gauge of reasonable value.

Use the capitalized earnings method to get your best idea of the most you would pay. Be sure to adjust the reported earnings appropriately before applying a capitalization rate. At the very least, factor in a reasonable cost for managing the business (even if you plan to do it yourself). Also factor in an annual replacement fund contribution for equipment. Carefully analyze all other expenses in the financial data. Some may be too high. (For example, personal expenses of the owner included in the business.) Others may be too low or missing altogether. Your goal is to develop the projected future income statement, but without adding in the extra value or sales increase that you hope to inject.

Capitalization rates are the return you want to earn on your investment. Recognize that this should be in addition to the compensation you receive for actually working in the business. That’s why it is important to factor in such compensation as an operating expense when doing the business valuation.

Running your own business is risky with a large downside. You can easily and very securely earn 5-6% with bank or large corporate obligations. You can probably earn 10-15% with growth stocks, trust deeds, and other slightly riskier investments. Therefore, it only makes sense to earn a minimum of 15%, and more likely 25-35%, on a business opportunity.

Assume a business earns $50,000 per year after your adjustments. If you want a 25% return (capitalization rate), that corresponds with a multiplier of 4. (Four times earnings gives you the price that would earn a 25% return on your investment.) Therefore, with these assumptions, you value the business at $200,000.

Typical multiples for private businesses range from 3 to 8. Lower multiples (and correspondingly higher capitalization rates) produce lower valuations. Factors to consider are risk, growth, history, and glamour. You would likely value most small private businesses at 4 to 5 times their adjusted earnings. This equates to a 20-25% return.

Recognize that many businesses for sale, after you make the necessary adjustments, are worth little or nothing. The seller’s asking price is often much higher than reality and careful analysis justify.