As a business owner in North Carolina, you’re busy. You might take care of day-to-day operations, approve budgets, have a hand in marketing, and of course, you’re always the go to for greenlights on big projects and decisions.
With all that taking place, you rarely have the chance to sit down and ask “What is my business actually worth?” Inevitably, though, that day will come. Whether it’s at the end of a particularly frustrating week, or you’re nearing retirement, you will eventually want to know how much your NC business is worth. If today is that day, you’re in the right place.
In this blog, we’ll break down what goes into a business valuation, various valuation methods for different business sizes, and types of buyers. In essence, this is your go-to guide to valuing your business in North Carolina.
Let’s get started!
Multiple of Earnings: Step by Step
As you become more curious about the value of your business, it’s important to learn about what valuation methods may be used to calculate a realistic asking price. The most common way to value a small business is the “multiple of earnings” approach.
Contrary to what some business owners believe, revenue is not a good indicator of a business’s value. Looking at a business's earnings is the best indicator of what it is actually worth.
Step 1 – Decide between SDE and EBITDA
The first step in a multiple of earnings valuation is to decide if you’ll use your company’s EBITDA (earnings before interest, taxes, depreciation, and amortization) or SDE (seller’s discretionary earnings). If you have a smaller business doing less than $1M in earnings, then it’s likely that SDE will be used. SDE represents the total earnings that a full-time owner/operator takes home each year.
Anything higher than $1M in earnings, and it’s likely that EBITDA will be used, depending on your involvement as the owner.
A business with a hands-off owner is more valuable to strategic and private equity buyers because they are usually also hands-off (or absentee) owners. If they see that a business can operate successfully without heavy involvement of the current owner, this makes it easier for them to hire someone to take over operations without the risk of things falling apart. In this case, EBITDA is a more appropriate metric to determine the business’s value, since it takes a fair-market officer’s salary into consideration.
Step 2 – Calculate SDE or EBITDA
Once you’ve decided which earnings definition you’ll use, the valuation specialist will calculate your SDE or EBITDA.
SDE is calculated by taking your business’s net profit and adding back certain discretionary expenses, including the owner’s salary. This is geared towards individual buyers who intend to take over as owner/operator.
EBITDA, on the other hand, is conducive to private equity and strategic buyers. It is calculated with the following formula:
Net Income + Interest Expense + Depreciation Expense + Amortization Expense + Taxes
This, however, is regular EBITDA, whereas your business will be valued using a multiple of adjusted EBITDA. To get the adjusted EBITDA value, you’ll have to add back any one-time expenses or revenue streams, and adjust your salary to a fair-market officer’s salary.
For example, if you paid yourself $200,000 per year, but an acquirer could replace you with a manager earning $100,000, you would add back the $100,000 in excess salary to paint a clearer picture of what the new owners will earn once you’re gone.
Step 3 – Calculate the Multiple
The next step is to calculate the multiple that will be applied to your earnings to give you the total value of your business.
But how does your valuation specialist determine the multiple that will be used? This all depends on the comps for other businesses in your industry that are ideally similar in earnings, size, and location.
The broker selling your business will use a database of the sales of comparable businesses in your industry to find an appropriate multiple, and then apply it to your business’s earnings.
Step 4 – Apply the Multiple
Once the multiple has been determined, it’s time to apply it to your SDE or EBITDA. Ultimately, this should give you the total value of your business.
For example, let’s say you own a manufacturing business that does $1.1M in EBITDA in a growing metropolitan area. Your broker will check the databases for other manufacturers with similar earnings and in a similar location. They’ll find that the average multiple for other manufacturers like yours is roughly 4.1 X EBITDA, which would give you a business value of $4,510,000.
The work, however, isn’t done just yet.
Step 5 – Buyer Test Method
The buyer test method is used to sanity check the value of your company to help determine if the new owner will realistically be able to pay off an SBA 7(a) loan while also taking home a reasonable salary. This is determined by ensuring that the annual earnings of a business meet, or preferably exceed, 1.25X the annual loan payment.
While 1.25 is the minimum margin required by the SBA, the buyer will want it to be much higher. With a margin of only 1.25, if the new owner loses an important customer, or sees even a slight dip in business performance, this could result in the inability to pay back loans while also taking a salary. For this reason, buyers prefer to see deals done with a margin exceeding 1.75.
While the buyer test method is centered around realistically paying back SBA loans, all buyers want to see this test passed to give them peace of mind about the risk they are exposed to after buying a business.
Who Should Value your Business
The process described above may sound simple, but it’s much easier said than done. For that reason, we recommend getting a quality business valuation from someone in North Carolina with plenty of experience.
There are a few options when choosing a valuation specialist. Some professionals who perform business valuations include:
- M&A Advisors
- Business Brokers
The number one priority in choosing one of these professionals is determining who does the most business valuations. In our experience, we’ve found that business brokers and M&A advisors tend to have the most expertise in business valuations. Since brokers and advisors have experience with selling companies, they should have the most knowledge concerning your business’s value based on the current market.
It can be difficult knowing who to choose to perform your business valuations. After all, the value of your business represents more than just an asking price. It determines what life looks like for you after selling, if you should sell now or wait, and whether or not you’ll have any long-lasting regrets.
Finding a broker with the right credentials and experience is key in getting an accurate business valuation. While we believe that the frequency and volume of business valuations performed is the best indicator of a good valuation specialist, you can also look for the following credentials:
- ABV (Accredited in Business Valuation)
- CVA (Certified Valuation Analyst)
- BCA (Business Certified Appraiser)
Remember, at the end of the day your business’s value is what someone will pay for it, and working with someone who regularly values and sells businesses is the best way to arrive at that number.
At MidStreet, we’re certified to perform business valuations, and have helped value and sell hundreds of small to midsize businesses in North Carolina since 2001. If you’re interested in receiving a free business valuation, or want to walk through a sample valuation, contact us today!