The Revenue Multiple (times revenue) Method
A venture that earns $1 million per year in revenue, for example, could have a multiple of 2 or 3 applied to it, resulting in a $2 or $3 million valuation. Another business might earn just $500,000 per year and earn a multiple of 0.5, yielding a valuation of $250,000.
For example, a business that is doing $300,000 in profit per year sold for at 2.44X would have a sale price of $732,000 ($300,000*2.44=$732,000). This works in reverse as well — if a business sold for $732,000 at 2.44X, then ($732,000/2.44) means the profit was $300,000.
To find the fair market value, it is then necessary to divide that figure by the capitalization rate. Therefore, the income approach would reveal the following calculations. Projected sales are $500,000, and the capitalization rate is 25%, so the fair market value is $125,000.
A business will likely sell for two to four times seller's discretionary earnings (SDE)range –the majority selling within the 2 to 3 range. In essence, if the annual cash flow is $200,000, the selling price will likely be between $400,000 and $600,000.
So as an example, a company doing $2 million in real revenue (I'll explain below) should target a profit of 10 percent of that $2 million, owner's pay of 10 percent, taxes of 15 percent and operating expenses of 65 percent. Take a couple of seconds to study the chart.
The Revenue Multiple Method
The revenue multiple used often falls between 0.5 to 5 times yearly revenue depending on the industry. For a company doing $2 million in gross annual sales, that could equate to a business valuation between $1 million (0.5X multiplier) up to $10 million (5X yearly sales).
While $3 million in sales is certainly impressive, it doesn't automatically translate to a specific valuation. The true worth of your business depends on a complex interplay of factors, including: Profitability: Your net profit margin (after all expenses) is a critical driver of value.
Growing a business is hard. Fewer than five percent of all businesses in the US grow to be more than $1 million in annual revenues. And fewer than one percent make it to $10 million. There are great number reasons why companies fail to scale to an Owner's desire or their dreams.
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Factors affecting small business valuation
Thus, buyers have to approach the deal as if they are purchasing a job. Businesses where the owner is actively-involved typically sell for 2-3 times the annual earnings of the company. A business that earns $100,000 per year should sell for $200,000-$300,000.
Current Value = (Asset Value) / (1 – Debt Ratio)
To quickly value a business, find its total liabilities and subtract them from the total assets. This will give you an idea of its book value. This formula estimates the worth of a business by looking at its assets and subtracting any liabilities.
$300,000 is a top 10% income. But unfortunately, making $300,000 will provide you a very middle class lifestyle in a big expensive city, especially if you have children. To make $300,000 usually means having to live in a more expensive city.
Companies with under $3m in sales will typically sell for 2.5 – 3.5 X their discretionary earnings (total cash the owner could take out of the company). Smaller companies that are even more owner-reliant will even be lower than that.
Business valuators determine the blue sky value by multiplying by pre-tax earnings by the blue sky multiple. The second element of the method is the net assets value (value of tangible assets) determined from the adjusted balance sheet.
The goal is to reach $100 million ARR (Annual recurring revenue) within five years and earn a $1 billion unicorn business value.
What's considered a good annual revenue for a small business depends on the size of the business. The average annual revenue for a small business with a single owner and no employees is $44,000 per year. As the number of employees starts to rise, so does the average revenue.
According to the 2024 survey findings, many U.S. small business owners have been growing while also facing labor challenges, which include being understaffed (52%), navigating a more competitive labor market (77%), and struggling to increase their employees' salaries to keep pace with inflation (65%).
According to 2022 data, a staggering 88 percent of millionaires are business owners, and there's little reason to believe that percentage has shifted much today. This statistic highlights a powerful truth: business ownership remains one of the most viable paths to achieving millionaire status.
This year's study reveals that Americans now think it takes an average of $2.5 million to be considered wealthy – which is up slightly from 2023 and 2022 ($2.2 million).
If the target store has annual revenue of $2 million, its estimated value would be $3 million.
While $2 million significantly exceeds the average retirement savings in the US, it can indeed provide a comfortable and fulfilling retirement. For example, retiring at 50 with $2 million could potentially yield an annual income of $50,000.
Discretionary Earnings Rule of Thumb
The discretionary earnings method starts with the annual cash from the business that's available to the owner after taking out essential operating expenses. It then multiplies that number by a factor usually between two and four, depending on the business type.
According to the most recent IBBA Market Pulse Report covering Q4 2021, the average time it takes to sell a business is 6-10 months. If you remove the smallest deals (<$500K), it's 8-10 months. The average time (in months) it takes to close a transaction 2017-2021 based on transaction size.
The number one sales rule to follow is to never end your day without taking at least one proactive step to put prospective business in the top of your sales funnel. That means making one call, asking for one referral, sending a letter, an email, or going to a networking event.