I’ve continuously stressed the importance of knowing your company’s value before you make a strategic move. Now I’d like to touch on a methodology you can use to make a valuation report so accurate that it will be within 5 to 10 percent of the value of an independent appraisal – and may be closer to your company’s real value.
We use this approach when we assess a company’s value, but be forewarned: This may not be the method a bank will require when you’re putting together a merger and acquisition or a succession plan. In that case, they’ll require an independent appraisal or certified valuation.
However, by determining your EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) and SDE (Seller’s Discretionary Earnings), and then comparing it with accurate industry benchmarks, you should get within 5-10% of the business valuation determined by an independent appraiser. In many cases, thanks to those industry-specific numbers, our method may be more accurate.
First, let’s look at EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” Technically, EBITDA is your measure of profits. Many businesses use it as a clearer proof of operations, as it strips out expenses that can skew your knowledge of how the company is performing.
To find the value, the EBITDA is multiplied by a capitalization rate(s) or factor(s) currently used in the industry.
The second number would be the seller’s discretionary earnings (SDE). This is a formula used for most businesses under $1 million in adjusted earnings.
With a small business, it’s more important to determine the “owner’s benefit” as opposed to the earnings of the business. The kinds of benefits the owner has established can significantly influence the bottom line.
Do EBITDA and SDE always compare with each other? Surprisingly, they don’t. However, we know from experience that if the results are within 5-10% of each other, we’re as accurate as we’re going to be.
I’ve just illustrated how to create a “preliminary value.” As I said before, a bank will not accept this, and will insist on using an independent appraisal expert who works with general accounting procedures.
However, this methodology will put you in the position to have a very clear picture of the actual value of the business. You’ll be able to understand the role of the business in estate planning, a merger and acquisition, or any other type of business venture where profit is distributed on the basis of value.
The Critical Number
Of course, all this is a moot point if you don’t have an accurate understanding of the capitalization rate used by your industry. Even many professional appraisers are not aware of the nuances within the printing industry, and how the specific markets are valued.
Again, I would not recommend this methodology unless you have critical industry benchmarks and insight. But, it can be a great starting point for evaluating your company value without having to hire a professional appraiser.
Photo by: 401(K) 2012