Buying An Existing Business Part VIII of IX

Valuing A Business


There are three basic approaches to valuing a small business: assets, market comparisons, and earnings,.

Buyers and sellers are adversaries; sellers want to sell the business for as much as they can and buyers want to pay as little as they need to. What process then should you use to value a small business?

The assets approach is useful but mostly when the value of the earnings is less than the value of the assets or when the earnings are in a downward trend with a doubtful future. Then the value of the assets becomes significant, particularly the liquidation value.

The market comparisons approach is to compare the subject business with businesses recently sold of similar location, type, and size. The idea is to adjust the actual sale prices and terms to align with the subject. This method is commonly used in real estate appraisals. It may also be used for franchises that are in many ways common. This approach, however, does not work well for small businesses in general because of their lack of commonality and also because the data needed to make market comparisons—actual sale prices and terms—are not usually a matter of public record. The market approach, therefore, is not very useful to small business valuation.

The value of a small business, and therefore its selling price, only makes sense when it's based on the cash flow or earnings approach. The cash flow approach is the one most important for valuing small businesses for the purpose of buying and selling. Using this approach, there are two methods of appraising: capitalization of earnings and preparation of cash-flow projections.

For more information regarding the cash-flow projections method:
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