To value a small private company, use a combination of methods like Income-based (Discounted Cash Flow or multiples of adjusted EBITDA/SDE), Market-based (comparing to similar sold companies), and Asset-based (tangible assets minus liabilities), adjusting financials for owner perks and non-recurring items to find normalized earnings, then applying appropriate multiples or projections to determine its worth, considering factors like growth, industry, and intangible assets.
Common methods to value private companies include the Discounted Cash Flow (DCF) and the Comparable Company Analysis (CCA). Factors influencing private company valuations include financial performance, industry and market conditions, growth prospects, intellectual property, and customer base.
Private Equity Valuation Metrics
Professional valuators typically use a mix of three methods to confirm the value of a business:
Service businesses typically sell for 2-3x their annual profit because they often depend heavily on the current owner's relationships and expertise. Manufacturing companies tend to command higher multipliers, often 4-5x their annual profit, due to their tangible assets and established processes.
The most commonly used rule of thumb is simply a percentage of the annual sales, or better yet, the last 12 months of sales/revenues.
12 common valuation mistakes
The income approach often uses the Discounted Cash Flow (DCF) method. This method estimates your company's current value by forecasting the cash it is expected to generate in the future and discounting those cash flows back to today.
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.
The 3-3-3 rule in sales is a versatile framework for structuring outreach and engagement, often meaning making 3 touches (calls/emails/social) over 3 weeks, or focusing on 3 seconds to grab attention, 3 minutes to build interest, and following up within 3 days, or even 3 contacts across 3 levels in a company to deepen relationships. It emphasizes consistency, clarity, and strategic focus in prospecting and nurturing leads to build stronger connections and improve conversion rates, according to various sales experts.
Warren Buffett's #1 rule of investing is famously simple and stark: "Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.". This principle emphasizes capital preservation and avoiding significant losses, suggesting that protecting your principal is more crucial for long-term wealth building than chasing high, risky returns. It means focusing on buying good businesses at fair prices, understanding what you invest in, and being disciplined to prevent large, permanent losses, even if it means missing out on some fast gains.
A good revenue multiplier typically ranges from 1 to 3 times annual revenue for most small businesses. However, this can vary significantly based on industry, market conditions, and specific business characteristics.
The Comparable analysis method is a simple yet effective approach to valuing your business. It involves estimating the worth of your business by comparing it to similar businesses in your industry. This method provides an observable value for your business based on the current market value of comparable companies.
In most industries, 30% is a very high net profit margin. Companies with a profit margin of 20% generally show strong financial health. If this metric drops to around 5% or lower, most businesses will need to make changes to remain sustainable.
Allow us to introduce the “Four Pillars of Value”: revenue, cost, risk, and time. These pillars are not mutually exclusive but together form a robust framework to articulate and maximize value. Let's break them down and see how they specifically apply to the legal services industry.
Common Valuation Metrics Explained