If you don’t understand what drives the value of your business, you might find yourself underprepared for critical decisions like selling, merging, or even planning for growth. Business owners who lack this insight often face undervaluation, missed opportunities, or stalled profitability.
At DHJJ, we’ve guided countless businesses through understanding their valuation drivers, ensuring they make informed and profitable choices.
In this article, you’ll learn the key factors influencing your business’s value, how valuations are calculated, and why having an accurate understanding of your business’s worth is essential—not just for transactions, but for creating a roadmap to long-term success.
Importance of Business Value
An accurate business valuation isn’t just critical when you’re preparing to sell—it’s a vital tool for making informed decisions. throughout the life of your business. Whether you’re considering major purchases, capital investments, or securing loans, having a clear understanding of your company’s worth provides the confidence to act decisively.
Many entrepreneurs focus solely on their business’s current income as a measure of its value. While income is important, it’s worth considering that your business is likely the greatest valued asset you own. Also consider that every business owner will at some point exit their business, whether it’s by choice or circumstance. Knowing your business value before you exit is key to avoiding unexpected and potentially costly surprises.
By proactively working to maximize your business’s value now, you can ensure a smoother transition when the time comes- avoiding scenarios like postponed retirement or diminished financial returns. Even if selling or exiting feels far off, obtaining a thorough and objective business valuation today helps you identify and optimize the key factors that drive value, setting you up for long-term success.
How Valuations Are Used
When preparing to sell a business, having an accurate valuation can save you from costly mistakes. Without it, you risk undervaluing your business and leaving significant money on the table.
For example, one DHJJ client initially received a $20 million offer to buy her business. Before accepting, we conducted a thorough valuation, revealing her business was actually worth $38 million—a substantial difference she would have missed.
Valuations also help business owners avoid potential pitfalls. For Example, Another DHJJ client was planning to merge with two other businesses. We performed a quality of earnings analysis, a valuation, and a value gap analysis that quantifies operational effectiveness and risk factors. The business owner discovered these risk factors were lowering his company’s value to the point that it did not make sense to merge at this time. This insight allowed him to postpone the merger and we developed a three-year plan to improve efficiency, grow recurring revenue, and strengthen his management team—ultimately boosting his company’s value to an acceptable level.
In addition to strategic planning, valuations are essential for other significant events, such as:
- Death or disability
- Exit or entry of partners
- Raising equity capital
- Converting from a C-corporation to an S-corporation
- Divorce
- Estate planning and gifting
- Creating an Employee Stock Ownership Plan (ESOP)
Being proactive about obtaining a valuation helps you plan ahead for these events. Instead of scrambling during a triggering event, you’ll have a clear strategy in place. Working with a qualified business appraiser ensures your valuation is reliable and actionable.
Types of Valuations
Valuation Calculators
Online tools like the BizEquity report we provide, are a great starting point for understanding your business’s value. These quick and low-cost calculators use basic inputs to generate an estimate, offering a convenient way to get an approximation of your company’s worth. However, while helpful as a starting point, these tools provide only a general idea and cannot account for the full range of factors that influence valuation. For a more accurate and comprehensive assessment, a full valuation performed by a qualified appraiser is essential, as it paints the complete picture of your business’s value.
Back of the Envelope
A common approach to determining business value is to look at historical transactions involving comparable businesses and calculate a ratio of the price paid to the company’s historical earnings, known as “multiples.” In theory, you can take the average multiple for your industry based on previous transactions and apply it to your business.
For example, if your bakery’s annual EBITDA is $1 million and the industry average multiple is 3.5x, your business would be valued at $3.5 million.
However, this approach often oversimplifies the process, ignoring key adjustments for expenses, unusual earnings, or transaction structures like asset sales versus stock sales—all of which can greatly affect valuation accuracy.
Qualified Valuation
The most reliable method is an in-depth analysis by an accredited appraiser (e.g., ASA, CVA, ABV) who has the training and expertise needed to provide a defensible business valuation report. These experts follow strict standards and use multiple approaches to determine business value. Because of the strict standards and procedures used, a qualified valuation will provide a defensible report for litigation or before the IRS.
Valuation Methods
Understanding the different valuation methods is necessary because each paints a unique picture of your business’ worth
Income Approach
The income approach focuses on historical financial performance while also forecasting growth opportunities and risk factors. This method often employs a discounted cash flow (DCF) analysis, converting future cash flows into their present value. For businesses with a less predictable future, the capitalization of earnings method—based on past performance—may offer a more accurate picture.
Market Approach
The market approach examines recent acquisitions of comparable companies, calculating a ratio of price to earnings or price to EBITDA (earnings before interest, taxes, depreciation, and amortization). A related method, the guideline public company approach, applies pricing multiples from publicly traded companies in similar industries to estimate your business’s value. While both techniques provide valuable insights, they work best when reliable, comparable data is available.
Asset Approach
This method considers your company’s net asset value by adjusting the balance sheet to reflect the fair market value of assets and subtracting liabilities.
Book Value
Book value is another asset-based metric that reflects the equity as shown on your balance sheet. This number offers a baseline but often undervalues intangible assets or growth potential.
Liquidation Value
The liquidation value estimates the proceeds from selling physical assets to pay off liabilities, leaving any remaining amount as the liquidation value. While useful in specific scenarios, this method doesn’t account for the business going concern value.
It’s worth noting that a business can have different values depending on the purpose of the valuation. Professional appraisers use these methods in combination, along with other factors, to determine the most appropriate valuation for your unique situation.
Risk Factors and Discounts
Risk plays a significant role in business valuation. Certain risk factors can reduce the perceived value of your business by 20% to 30%, potentially turning a $20 million valuation into $15.3 million. These swings highlight the importance of addressing risks proactively. Increasing revenue and profits is one way to enhance your company’s value, but mitigating risks can be just as impactful.
Concentration risks
If a business relies heavily on one or two major customers, there is a risk of declining profit if that customer is lost. A well-diversified company is worth more. Concentration risk is viewed as any customer that makes up 10% or more of total sales. This can also apply to vendors and suppliers of the company. f losing a single customer or supplier could cause significant disruption, the perceived value of your business will drop. Diversifying your customer base and supplier network can significantly reduce this risk.
Operational risks
Operational risks also weigh heavily on valuation. Poor management, lack of internal controls, outdated processes, and inadequate financial reporting can all lead to inefficiencies that hurt your company’s value. Valuation professionals often analyze over 150 operational factors to assess how these issues might affect your business.
Key person risk
Unlike operational risks, a business may be well-run but heavily dependent on a single individual, such as a founder or CEO. If the success of your company hinges on one person, the loss of that individual could jeopardize the future of the business, leading to a lower valuation. Building a strong management team and reducing dependency on any single person can help mitigate this risk.
In business valuation, discounts adjust the value of a business or ownership interest to account for factors that might make it less attractive or valuable to a potential buyer. These discounts are particularly relevant to minority interests, where lack of control and limited marketability often play significant roles in reducing the perceived value.
Common valuation discounts
Discount for lack of control (DLOC) – when a person holds a minority share or noncontrolling interest, they lack the ability to make decisions about the business.
Discount for lack of marketability (DLOM) – This discount is typically applied to non-publicly traded companies and suggests that a privately held company is much harder to sell and takes longer than a publicly traded company.
By addressing these factors, you can make your business more appealing to potential buyers and improve its overall valuation.
Other Factors
Types of Buyers
The value of your business is also influenced by who the buyer is. Buyers typically fall into two categories: financial buyers and strategic buyers. A financial buyer, such as a private equity firm, focuses primarily on profitability and financial performance. In contrast, a strategic buyer—another company in your industry—may be willing to pay a premium not only for profitability but also for synergies like market share, complementary products, or competitive advantages. Strategic buyers often drive higher valuations due to their broader goals.
Economic influences
Economic conditions can also impact valuation. Factors such as inflation, interest rates, supply chain disruptions, and workforce shortages can affect profitability and gross margins. These influences are especially significant in income-based valuations, as they directly alter future earnings and cash flow expectations.
Recurring Revenue
Recurring revenue is another critical factor. Predictable income streams, such as subscription-based revenue models, significantly enhance business value because they reduce risk. Unlike one-time sales or project-based work, recurring revenue offers stability and makes your business more attractive to investors and buyers. While non-recurring revenue can contribute to short-term gains, it lacks the long-term predictability that recurring income provides. Businesses with strong recurring revenue streams consistently achieve higher valuations, as they project a more secure and stable future.
Partnering with DHJJ to Maximize Your Business’s Value
Understanding the value of your business isn’t just about preparing for a potential sale or merger; it’s about equipping yourself with the knowledge to make strategic, confident decisions at every stage of your business’s lifecycle. From choosing the right valuation method to identifying and mitigating risk factors, a thorough and accurate valuation gives you the clarity needed to maximize your business’s potential.
At DHJJ, we understand the complexities of business valuations and how critical they are for success. Whether you’re looking for a starting point like our BizEquity report or require a full, detailed valuation, our team of financial experts is here to guide you through the process. We don’t just provide valuations—we deliver actionable insights tailored to your business’s unique needs.
Our services include:
- Valuation Service
- Outsourced CFO Services
- M&A Advisory services
- Quality of Earnings Analysis
- Audit Services
- Operational Effectiveness Analysis and Value Gap Analysis
With DHJJ as your partner, you’ll have access to the expertise and tools necessary to strengthen your business’s value, seize opportunities, and achieve your long-term goals.
If you’re ready to take the next step in understanding your business’s worth or improving its performance, contact DHJJ today. Together, we’ll build a clear path toward maximizing the value of your greatest asset.
