I remember in college, in a business finance class, we did calculations on how to value a business.
They made it seem so stinking easy in that darn class. Take the net present value of future cash flows at a certain discount rate and viola! A nice tidy business valuation.
The reality is that a business, especially a small business, is incredibly difficult to value and that it is really only worth what someone is willing to pay for it.
I’ve been thinking about this a bit lately because at some point, when doing my balance sheet, I need to come up with a valuation for my small business. I’ve really worked hard on working myself out of the business as much as possible the last 6 months and it’s getting to a point where I could really have one person run it and not really be involved at all. Which is great, because one of thing that kills small business valuations the most is that the equity and value in the business is all tied up in the owner.
So, at some point I will add a line on my balance sheet for my business. It just doesn’t seem to make sense not too anymore.
Someday I think I’d love to buy undervalued businesses and try and flip them like houses. I think that could be really a ton of fun. But that is a ways off.
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I too share in the desire to flip businesses, especially bars and restaurants. It's harder to do because there is less of a market to re-sell. I saw it a lot in college though because my favorite finance professor was a part of an LLC that specialized in it.
As for valuing your own business, that's some hard stuff. You can also try using 10-20x earnings or 5-10x EBITDA. It's at least a good way of tracking your own value's growth over time.
As a financial analyst, I see valuations as the meat and potatoes of my work. Your comment is spot on – something is only worth what someone else will pay for it. The difference between what someone will sell it for (bid) and what someone will buy it for (ask) is known as the bid-ask spread which is a measurement of liquidity.
Selling a business is much less liquid than something like T-notes. This naturally leads to a higher bid-ask spread. In order to accurately value your business, I would suggest the following methods:
1) Equity (assets less liabilities). If you sold off every component of the business, what would it be worth? this is a safe worst-case scenario.
2) Discounted cash flows. (You already mentioned it but I would think of this as the high price of your business since it takes growth and futures earnings into account).
3) Comps. What is a comparable business (similar market, customers, volume, debt level, etc) saying it is worth? If a similar business has half the volume, would yours be worth twice as much?
Start with the Balance Sheet. How much equity does it have?
Next look at the Income Statement. What is the return on the investment?
How much would it take to invest in something with similar risk to make a similar income?
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