Small Business Valuation using Rules of Thumb.

1. Demystifying Small Business Valuation
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Small Business Valuation

2. Demystifying Small Business Valuation
 Valuing businesses is of paramount importance to
a small business. It is one of the several metrics
used to ensure the business is growing and
creating value for the owners.
 There are several valuation methods one can use
to determine the intrinsic value of a company.
 Valuation techniques are broadly classified as
 Asset value methods
 Earnings value methods and
 Market Value based methods

3. Demystifying Small Business Valuation
 The valuation techniques are based on discounted
future cash flow (DCF), discounted future earnings
and industry specific multipliers.
 Rules of thumb are commonly used by business
brokers to determine the price of a business and
simplify the valuation process.
 Values determined using “Rule of thumb” are
simplifications and only an estimate of the true
value of the business.
 “Rule of thumb” must be used as a staring point
before conducting detailed due-diligence to
determine the correct value.

4. Demystifying Small Business Valuation
 A common approach to valuing a business is to use
earnings or sales multiples.
 This approach directly addresses a buyer’s motive of
estimating the return on investment (ROI) on deals.

5. Demystifying Small Business Valuation
 Real Estate is historically priced at 8 to 10 times
its net operating income (EBITA).
 Stock markets are typically priced at 12 to 20
times earnings.
 These multiples do not apply to small businesses
as the risk premium associated with a small
business is much higher than managing a
building or a stock portfolio.
 The first step us to determine which multiplier to
use.
 factors to consider include determining the
composition of earnings.
 Generally the preferred earnings to use are

6. Demystifying Small Business Valuation
 Normalized earnings are adjusted for cyclical
changes in in the economy and one time one-
time influences.
 The multiplier is based on risk and there usually
are “Rules of Thumb” multiplier numbers
depending on the industry.
 Tangible and Intangible assets have a value that
is separate from the business.
 Therefore the best way to treat tangible/intangible
asset is to separate them from the business and
then add them back to the multiple derived value
of the business.
 Multiples used are very specific to a business and
location of the business but broadly speaking it
can be between 2 to 5 times normalized EBIT

7. Disadvantages and caveats
 In reality there is no perfect price and techniques
described in the earlier sections are just
guidelines to derive an acceptable price.
 The “Rules of Thumb” approach does not provide
sufficient information to assess the uniqueness of
the business, such as management depth,
customer relationships, industry trends,
reputation, location, competition, capital structure
and other information that is unique to the
business.
 Proper evaluation will go beyond calculations
based on multiples and tangible/intangible asset
values. It requires complete business, marketing
and financial due-diligence.

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