Why You Should Know What Your Business Is Worth and How to Determine Its Value
By Jay DesMarteau
TD Head of Commercial Distribution
If you're considering taking on an investor, knowing the value of your business is vital to negotiation
Before accepting any money from a potential investor, it's first important to understand the value of your business. This is essential to determine the appropriate amount of the investment and how much of an ownership stake the investor should have—based on their funding and other value they can bring to your company.
4 ways to determine the value of your business
Your business valuation can be determined by a variety of factors, including total assets, total liabilities, current earnings, and projected earnings based on the quality of your idea and market potential. While there's no right way to determine this valuation, it's a good idea to have it looked at from different perspectives, so an investor or potential partner can see you've done your due diligence.
1. Book value of your business (asset value)
Take your total assets and subtract your total liabilities. This approach makes it easy to trace to the valuation because it's coming directly from your accounting/record keeping. However, because it works like a snapshot of current value it may not take into consideration future revenue or earnings.
2. Cash value analysis
If your business has a good understanding of its cash flow analysis, you're already taking into account your current and future potential earnings. This measure can be applied over a specified period of time. If you don't already have this perspective, a CPA, online accounting software, or other type of financial planner can help prepare this for you. Another variation on this can be a discounted cash value analysis, which considers the value of today's money under tomorrow's economic conditions.
3. Revenue multiplier
A less sophisticated but still popular way to determine a company's potential value quickly is to multiply the current sales or revenue of a company by a multiple "score." For example, a company with $200K in annual sales and a multiple of 5 would be worth $1 million. The more confident an investor is about getting a return on their investment, the easier it is for you to command a higher multiple. The multiple used can vary widely based on a variety of factors, including:
- The industry: Competitive landscape, profit margins, macros trends, risks, etc.
- Market potential: Is there a market for your idea? Learn how to test the market for your business idea. If there's potential, how much money does an investor think your business could make in the short or long term?
- Timing: When will your business start making money, or how fast will it grow? Investors generally like a quick return, but some may be patient enough to stick around long term, with the hope of realizing the full potential of a business' success
- Management team: The value you and/or your team brings to the company and your ability to improve its potential for growth
- The idea & the investor: The better the idea, usually determined by how much value or growth potential it offers, the more an investor might pay. Different people may value your idea differently, based on their opinions, expertise and more, so don't take one nay-sayer as the final answer
While the revenue multiplier is considered one of the easiest methodologies to determine the value of your business, for credibility, it's best to have this done by an independent third party.
4. Earnings multiplier
This method, also known as a price-to-earnings ratio, is more widely used if you have shareholders. This method takes the Price Per Share (PPS), the current market trading price of a company's share, and divides it by the Earnings Per Share (EPS). This gives you the net profits earned by the company per share in the market. The higher the EPS, the better. Ultimately, this allows comparison between the share price of a company to similar companies in the market. You may have to prepare two views: one that shows earnings before taxes and one after taxes.
TD Bank also has partnered with Biz Equity to help customers determine the value of their business.
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