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Valuing a Business: How to Value a Small Business For Sale

most investor and strategic businesses

worth more than a million dollars are

valued according to a multiple of EBIT

or EBIT de this is the mark of their own

M&A advisory businesses cover however

the vast majority of businesses are even

smaller and worth less than 1 million

dollars fully 95% of all businesses are

in this category typically employing

fewer than 10 people and are affordable

by most aspiring individual business

owners so in this video we're going to

be covering how to value 95% of all

businesses

the key to knowing how these businesses

are valued lies in what those aspiring

buyers see in the business usually they

expect to work in the business and earn

both the business profit and the owners

wage we call this the buyer job market

whereas the job that comes with a larger

business is a liability and the

strategic investors have to replace the

departing owners or operators the

vacancy is one that the new owner can

expect to fill

therefore the owners wages are as of as

much value as the business profit in

another video we've suggested that an

appropriate profit measure for these

businesses is net profit before

proprietors wages which may be one or

more working owners so now with both the

business profit and the owners salary of

value the appropriate market of

intending working owners values this

type of business more highly than a

corporate or general investor would the

difference between what a corporate or

general investor would pay and what a

buy a job buyer would pay is called the

small business premium if the business

makes two hundred thousand after paying

everyone including the working owners

then the investor would value the

business based on the 200k of it and may

be prepared to pay say six hundred K all

up at a three times multiple including

stock and other working capital and

plant and equipment that is if they were

interested at all in such a small

business however a buyer job buyer will

see not only the $200,000 EBIT but also

the $150,000 been taken home by the

working owners they may pay a multiple

of the three hundred and fifty thousand

dollars however in the market for these

small businesses applying a multiple to

this three hundred and fifty thousand

dollars is fraught with danger and has

no technical basis nevertheless many

buyers may be prepared to pay a say for

plant and equipment plus stock plus one

or more years net profit before

proprietors wages which

could yield a value for that particular

business materially higher than the

$600,000 true investor value many of

these buyers also may disregard the true

working capital requirement of the

business being those items already

mentioned to stock plus the trade

debtors less the trade creditors however

they'll still have to fund the trade

debtors less the trade creditors going

forward now such evaluation formula may

be according to empirical rules of thumb

this kind of valuation method has very

little technical basis but the factor

that is used at all means it creates the

need to recognize it however I recommend

a more cautious approach and using a

supported valuation method and see the

rules of thumb as ro T or rot which is

what they can produce by way of a value

with so many very small businesses

turning over and going to the wall it is

no wonder when such unsophisticated

valuation methods are applied on a

widespread basis and have been for many

years so my message here is exercise

high caution when departing from proven

business valuation methodology even

though you may miss out on acquiring

such a business by being beaten to the

post by someone who is less informed and

perhaps more gung-ho if you do intend to

pay a premium do so with your eyes open

and make sure your true business profit

is at least known before you make such

an offer all the best