Valuing a publicly traded company is easy; you simply multiply the company’s stock price by the number of shares outstanding. Unfortunately, determining the value of a privately owned business isn’t always so transparent. And if you operate a niche business, the valuation process can be even more complex. Nevertheless, it’s important to know how much your business is worth—even if you have no immediate plans to sell. In this article, we’re sharing how to value a niche business when standard industry multiples don’t exist.
Why do you need a business valuation?
A reliable business valuation is a key component of a successful exit strategy. Surprisingly, less than 40% of small business owners have had a formal valuation conducted in the last three years, according to one Exit Planning Institute study. And 65% have never had their financial statements audited.
If you plan to sell your business one day to fund your retirement, knowing how much your business is worth is critical. Even if retirement is years in the future, valuing your business now can help you avoid a savings shortfall. Moreover, you can use this information to maximize the transferable value of your business prior to selling.
Why is it more challenging to value a niche business?
A professional business valuation can cost anywhere from $3,000 to more than $30,000, according to INNP, a valuation and consulting firm. Consequently, many small business owners rely on rules of thumb to determine their business’s potential sale price. For example, a common rule of thumb is to base your business’s value on a multiple of revenue or EBITDA.
Unfortunately, this rule of thumb isn’t always accurate. In addition, it only works if your industry has a common multiple. If you operate across industries, sell unique products or services, or own a franchise, there may not be a standard valuation method for your business.
When this is the case, it’s usually helpful to work with a professional valuation specialist, CPA, or exit planner. In the absence of professional assistance, you can also use an income-based approach to value a niche business.
The Income Approach
Two income-based approaches are commonly used to value a privately owned business. The first approach is the capitalization of cash flow method. The second is the discounted cash flow (DCF) method.
The capitalization of cash flow method takes a single benefit stream and assumes it grows at a steady rate into the future. This approach is typically used to value mature businesses with modest future growth expectations.
The DCF method can also be used to value steady growth businesses. However, it’s more flexible than the capitalization of cash flow method. For example, it allows for variations in margins, growth rates, and debt repayments. For many business owners, this increased flexibility makes it easier to account for variables that can significantly impact business value.
The DCF method calculates the value a buyer would be willing to pay for a business given a required rate of return on their investment. This required rate of return is also called a discount rate. Most businesses use weighted average cost of capital (WACC) for the discount rate.
Keep in mind that both income-based approaches are only as good as the assumptions you put into them. Indeed, you can calculate business value yourself using either of the methods described above. However, working with a valuation specialist can help ensure your assumptions are reasonable.
If You Plan on Retiring, Don’t Wait to Value Your Niche Business
Studies show that only 30-40% of businesses listed for sale ever sell. Oftentimes, this is due to inadequate preparation by the owner, including failure to obtain an accurate business valuation. When your business is your largest asset, an inability to sell can result in a devastating financial shortfall in retirement.
No matter what type of business you own, it’s beneficial to start planning your exit as early as possible to secure your financial future. The more time you give yourself, the more options you’ll have when it comes time to sell your business and retire.
Oak Capital Advisors specializes in exit and retirement planning for small business owners. If you’d like to speak with a CFP® Professional and Certified Exit Planner™ about developing an exit plan and personal retirement plan, start by requesting your complimentary retirement readiness assessment.
