How To Value A Business – Complete Guide To Valuing Privately Held Companies

FAQ

Do business buyers always come to similar values as one another?

No.

While the math adds up to be the same for everyone, the inputs and assumptions around growth that buyers will make in their valuations vary greatly. 

We often-times see 10+ bids on companies we represent and the highest 3 bids will be nearly twice the price of the lowest bidders.

Other factors will also play into how an individual buyer group values a business.

  • Do they already have a platform (larger business) in the space?
  • Do they already have a new CEO lined up?
  • Have they raised money with a narrow mandate and MUST invest in this sector.
  • etc.

Yes and No.

While growth equity and venture capital investors are still fundamentally valuing the business based on the present value of its lifetime profits. They are often-times investing in companies that aren’t yet turning a profit and can even be pre-revenue.

Growth capital, such as what venture capitalists provide, goes onto the company’s balance sheet as opposed to being exchanged for ownership of the business.

No.

All of the valuation principles we’re discussing below are true of both privately held and publicly traded companies. Furthermore, the principals of risk, reward, growth, time value of money, etc. that are discussed can be applied to any investment.

However, publicly traded companies typically trade at much higher multiples of these valuation metrics.

There are some nuances in that Public companies don’t use EBITDA as a metric or trade on a cash-free and debt-free basis the way privately held companies do.

How to Value a Business (90 Second Overview)

The crash course on how to value a business is that your company’s financial performance (usually the adjusted EBITDA, also known as discretionary profit) is calculated, and then the buyers will submit bids for the business based on a multiple of that figure.

The multiple will be higher or lower based on how desirable your business is. Some of the factors that these buyers will consider are:

  • Industry
  • Size
  • Owner reliance
  • Differentiation
  • Margin
  • Leadership team

Note that valuation is more art than science. Running a competitive auction process to get multiple bids for the business is a sure-fire way to optimize the value at time of exit.

What is a Business Valuation Multiple?

A valuation multiple is a number applied to a company’s financial performance metric to arrive at that company’s value.

When coming up with the appropriate value for a company, it is important to understand the inherent benefits and risks associated with both that industry and that particular business.

Considering factors such as a company’s strong growth prospects, or the difficulty the buyer might face in replacing the CEO will play into the multiple that they arrive at.

Valuation multiples can offer a quick, back-of-the-napkin approach to valuing a company.

What Number is This Multiple Applied to?

The valuation multiple is most often applied to the company’s adjusted EBITDA to arrive at the final value.

Adjusted EBITDA (earnings before interest, tax, depreciation and amortization) is meant to be a metric that shows how much cash a new owner would be able to take out of the business AFTER a new CEO is paid, but before accounting for interest, tax, depreciation, and amortization.

In addition to adjusted EBITDA multiples, there are occasions where revenue multiples make sense. We’ll dig into these scenarios a bit more below.

Income, Profit, Earnings, Adjusted EBITDA. Are They All The Same?

No. Adjusted EBITDA is the metric that is most commonly used in valuing privately held companies. This means that the owner’s CEO has been normalized for what a new operator will need to be paid and that other discretionary expenses have been added back into the company’s profitability.

Seller’s discretionary earnings (SDE) is the same metric that is more commonly used when talking about small, main street sized companies. We’ll use those terms interchangable.

Looking For A Business Valuation Calculator?

Looking to skip the lecture and see what your business is worth? Check out our business valuation calculator and request a valuation. Note that we don’t have the bandwidth to provide valuation guidance for startups at this time.

Valuation Along the Growth Curve

The income statement visualization (below) is designed to show the expansion stage of many growth companies.

You’ll see that the years of modest growth (2020 and 2021 in this example) both have meaningful capital expenditures (CapEx). This indicates that they are reinvesting profit back into the business to create a new/better product or service for the future. 

If the business was to be valued in these early years (2020 and 2021), a revenue multiple (or DCF) would be the appropriate valuation methodology.

If however, the business was held until the full capex investment was realized in the form of increased revenue, AND, no further growth investments were made (as seen below for year 2025), an earnings multiple would be the appropriate valuation methodology.

Revenue or earnings valuation multiple

Is this similar to a J Curve?

Yes and No.

The above visualization shows a company that is already profitable. You could imagine it as the latter stages of a J curve. (see below)

J curve valuation for companies

What Is a Revenue Multiple and When is it Used?

Because most private market investors (private equity groups, family offices, entrepreneurs, etc.) are focused on how much profit a business makes, valuing a business based on its profit (adjusted EBITDA) rather than its revenue makes far more sense.

While investors vary in what they look for in target companies, the majority of them agree with the sage words of Mr. Buffett and look towards the bottom of the income statement as opposed to the top.

"Value can be defined simply: It is the discounted value of the cash that can be taken out of a business during it's remaining life."

While most investors follow Warren’s advise and look only at profitable companies, there are some groups (growth investors) who care far more about the cash the business will make  years down the road than what it makes at the present day.

These investors will gravitate more towards companies that are reinvesting all of their discretionary earnings back into the business to fuel growth as opposed to those that are pulling cash out of the business. Therefore, the most appropriate metric to value the business on is top-line sales/ revenue.

Growth equity investors and venture capital firms are two examples of firms that will care more about revenue, revenue growth and what the coming decade looks like than they will about current profitability.

When is Adjusted EBITDA Used in Valuation

Applying a given multiple to a company’s adjusted EBITDA is the industry standard valuation methodology for privately held companies.

To make a business appealing to the majority of investors, show them how much cash they can take out of it over the next 3-5 years. 

This means that the business should be well into its “harvesting phase” by the time you elect to sell. 

It can (and hopefully is) still be growing, but the business should be able to pay the majority of its earnings out as distributions to the owner(s) when it is sold.

We put together another blog all about EBITDA Valuation Multiples for privately held companies.

Is an EBITDA Multiple the Same as an Earnings Multiple (P/E) of a Publicly Traded Company?

Similar, but not quite the same.

When private companies trade hands, they are recapitalized and the assets are moved over to a new corporation and the assets will have a new depreciation schedule.

Because of this, the new owner will pay a different amount in interest, taxes, depreciation and amortization. Therefore, these line items are removed from net earnings to arrive at EBITDA.

Shares of publicly traded companies trade hands every day without the business being recapitalized. Therefore it is more common to use an earnings multiple (P/E) as opposed to EBITDA multiple as with private market transactions.

Thinking About Selling?

If you are entertaining selling your company, feel free to request a consultation with one of our business brokers or M&A specialists to learn about our unique process and why we believe it is the best in the industry.

Should My Company Be Valued With a Discounted Cash Flow Model (DCF) Instead?

You aren’t missing anything by not building a DCF model to value your company.

A discounted cash flow is a valuation method that forecasts future cash flows and then applies a discount to them to account for the fact that they have not yet happened and the risk that they may not happen.

Many private equity groups and other investors will use a DCF model to come up with the value they are willing to pay for a business. However, they will still submit their bid with the equivalent earnings multiple.

Using an earnings multiple is a much easier method for buyer and seller to agree to and to arrive at the actual cash that changes hands on closing day. 

How Do You Value a Business That is Growing?

Regardless of what methodology you are using to value the business, you will price in what the risks and growth expectations are for that business.

If you expect a business to have minimal risk and high growth, you would just apply a higher multiple to it. Or, use a lower discount rate in your DCF model.

What About Comparable Sales and Precedent Transactions?

There are none…

The private markets are historically very vague when it comes to what deal terms are.

Even if there are comps and precedent transaction multiples to work from, there are enough variables in the deal structure, leadership position of the target company, and background of the acquirer that the metrics are not terribly helpful. 

For instance, a growing business that trades at 6X Adj. EBITDA with 90% cash at close may be a better deal for the seller than a business that trades at 7X with 25% rollover, 25% earnout and only 50% cash paid at close.

Related Content

Have a look at the article we created all about revenue multiples.

How To Get The Most For Your Business

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What Is The Rule of Thumb for Business Valuation?

Main Street Deals (Sub $3m Revenue)

90% of small businesses in America generate less than $3m in annual sales (revenue), so we’ll start there.

Companies with under $3m in revenue will typically sell for 2.5 – 3.5 X their discretionary earnings (total cash the owner could take out of the company. Smaller, owner-reliant companies will even be lower than that.

It’s also important to note that we recently sold a SaaS company for $10.6M that only had $2.5M in revenue and $1.5M in Adj. EBITDA, so this is just meant to be a guideline.

Lower Middle Market Deals ($3M - $100M Revenue)

There is no ‘rule of thumb’ here. Some of these deals (small, owner-reliant, cyclical industry, thin margins, etc.) won’t sell at all.

On the other end of the spectrum, high-growth, sizable, differentiated, defensible, wide-margin tech and tech-enabled companies will sell for 10X+ revenue and 20X+ profit

Publicly Traded Companies (Typically $100M+ Revenue)

Publicly traded companies trade at a meaningful premium to that of private market companies. 

There doesn’t seem to be any ‘rules of thumb’ on how valuations change from being large, privately held companies to small-cap publicly traded companies.

What Business Assets are Included in the Sale / Valuation?

The vast majority of business transactions take place on a cash-free and debt-free basis with an ordinary level of working capital.

This means that all of the business assets and liabilities are included in the sale except for cash and long-term debt. It is the seller’s responsibility to pay off all long-term debt at the time of close. They also get to keep all of the cash that is on the company’s books.

An “ordinary level of working capital” is typically calculated by looking at the month-end balance sheets for the past 12 months and averaging the level of short-term assets (less cash) and short-term liabilities (less debt).

Request A Consultation

At Raincatcher, we represent entrepreneur and family-owned businesses between $2m – $50m in enterprise value in selling their company. Occasionally we will help them in their efforts to grow through acquisition as well through our outsourced corporate development service.

If you’re entertaining selling and looking for some guidance, feel free to contact us and tell us a bit about your company. We’ll match you with the team member who is most capable of working with you for a complimentary consultation.