7 Business Valuation Methods All Entrepreneurs Should Know

1.Market Value

2.Asset-Based Valuation

3.ROI-Based Valuation

4.Discounted Cash Flow (DCF)

5.Capitalization of Earnings

6.Multiples of Earnings

7.Book Value

What is your business worth? You might need to determine this value for a number of reasons, not
the least of which is when you’re seeking investors or other types of small business financing.
That’s the job of business valuation methods. 

A common way of answering this question is by taking a look at your balance sheet, which will give
you the “book value” of your business, or total equity (which is what your business is worth at a
given moment in time). In truth, however, your business’s book value is just one of many business
valuation methods out there, all of which take different factors into consideration.

Here, we’ll teach you about the three major business valuation methods all entrepreneurs should
know—market value, asset-based, and ROI-based business valuation methods—plus four more
business valuation formulas, which are a bit more specific.

Even if you hire a broker to value your business, it’s important to understand how these calculations
work. So let’s dive deeper into these major business valuation methods.

Where does your business need the most help?

● I need financing for my small business
● I don’t have a business yet but I’d like to start one
● I’m a new startup and need help growing my business
 ● Not sure. I was just looking for some small business advice.

What Are Business Valuation Methods?

Before we dive into the details on the different types of valuation methods, we’ll need to solidify
what exactly a business valuation is.

Put simply, all business valuation methods are ways to determine how much your business is
currently worth. Included in these calculations are the values of your equipment, inventory,
property, liquid assets, and anything else of economic worth that your company owns. Other factors
that might come into play are your management structure, projected earnings, share price, revenue,
and more.

Business valuation methods will come in handy in multiple scenarios. Of course, you’ll need to use
them if you’re in the process of selling your business. However, you’ll also need to consult them for
other situations, such as establishing partner ownership percentages, when seeking financing, or
even in divorce proceedings.

As we mentioned, there are many business valuation methods out there. The best valuation
approach typically depends upon why the valuation is needed, the size of your business, your
industry, and other factors. For instance, in a sale scenario, the majority of small private firms are
sold as asset sales, while the majority of middle-market transactions involve the sale of equity.
These scenarios would necessitate different approaches to business valuation. 

Keep in mind that both business owners and buyers should hire brokers to assist in this process, as
they can give you the most objective business valuation possible.

3 Major Types of Business Valuation Methods

There are many kinds of methods out there, and some will serve you better than others, depending
on your situation. That said, the following three business valuation methods are fairly standard, and
all entrepreneurs should have them in their tool belt.
1. Market Value Business Valuation Method

A market value business valuation formula is perhaps the most subjective approach to measuring a
business’s worth: This method reaches the value of your business by comparing it to similar
businesses that have sold. Of course, this method only works for businesses that can access
sufficient market data on their competitors. It’ll be a particularly challenging approach for sole
proprietors, for instance, because it’s difficult to find comparative data. You won’t have a public
database to go by.

As this small business valuation approach is relatively imprecise, your business’s worth will
ultimately be based on a negotiation, especially if you’re selling your business or seeking an
investor. You may be able to convince a buyer of your business’s worth based on immeasurable
factors, but a savvy investor can see through that.

All that said, this valuation method is a good preliminary approach to gain an understanding of what
your business might be worth, but you may want to bring another approach to the negotiation table.
That brings us to the asset- and ROI-based approaches.

2. Asset-Based Business Valuation Methods

Next up are asset-based business valuation methods. As the name suggests, these approaches
consider your business’s total net asset value, minus the value of its total liabilities, according to
your balance sheet.

There are two main ways to approach asset-based business valuation methods:

Going Concern

Businesses that plan to continue (i.e., not be liquidated), and that none of its assets will be sold off
immediately, should use the going-concern approach to an asset-based business valuation. This
formula takes into account the business’s current total equity (or assets minus liabilities).
Liquidation Value

On the other hand, the liquidation value asset-based approach to valuation is based on the
assumption that the business is finished and its assets will be liquidated. The net amount is what
would be realized if the business is terminated and its assets sold off. The value of its assets will
likely be lower than usual, because liquidation value often amounts to be much less than fair market
value.

The liquidation value asset-based business valuation method operates with a sort of urgency that
other business valuation methods don’t necessarily take into account.

3. ROI-Based Business Valuation Method

Let’s take a look at ROI-based business valuation methods from a very practical standpoint. When
you’re considering investing in something, what is your primary concern? Probably, it’s your return
on that investment, or ROI. If you buy stock in a company, you want a return. But what’s
considered a “good” ROI ultimately depends on the market, which is why business valuation is so
subjective.

To see the ROI-based method in action, let’s take a look at the TV show “Shark Tank.” (You can
learn a lot about business valuation from watching this show if you pay attention.)

The first thing a “Shark Tank” contestant does when they come on the show is tell the sharks how
much of an investment they’re seeking, and what percentage of their company they’re willing to
give up in exchange. At that very moment, they are valuing their business.

Notice the sharks immediately write something on their pads. Although viewers never see their
pads, it’s likely that, in most cases, they’re writing down the valuation at 100%.

The math here is simple: Divide the amount desired by the percentage offered, and you have the
business valuation at 100%. So if you ask for $250,000 in exchange for 25% of your business, then
you’re valuing your business at $1 million. And with that simple statement, you’ve performed a
mini-valuation right on the spot.
Still, if you’re using the ROI approach to seek investors or buyers, you’ll still need to convince
those investors or buyers of this valuation. Here’s what the sharks need to know in the end:

•How long will it take to recover my original investment?

•After that, when I look at my share of the expected net income, compared with my investment,
what does my return look like?

•Is that number realistic? Ambitious? Conservative?

•Does it make me want to invest in this company?

All of these questions will inform an ROI-based business valuation. If you want to learn more about
this method, watch the short video posted below.

And 4 More Business Valuation Methods You Should Know

The three methods we mentioned above are important umbrella approaches to understand. But as
we also mentioned, there are several ways to approach small business valuation, and what works for
one business may not work for yours.

Because we always favor more knowledge over less, here are a few additional methods you might
want to learn:

1.Discounted Cash Flow (DCF): Also known as the income approach, the DCF

method values a business based on its projected cash flow, adjusted (or discounted) to its
present value.

2.Capitalization of Earnings: This method calculates a business’s future profitability based

on its cash flow, annual ROI, and its expected value. The Capitalization of
Earnings valuation method works best for stable businesses, as the formula assumes that
calculations for a single time period will continue.
 3.Multiples of Earnings: Also known as the Times Revenue Method, this formula
calculates a business’s maximum worth by assigning a multiplier to its current revenue.
Multipliers vary according to industry, economic climate, and other factors.

4.Book Value: Don’t forget about this business valuation method, too, which we mentioned
earlier. This formula calculates the value of the business’s equity (or total assets minus total
liabilities), as per the business’s balance sheet.

Which of These 7 Business Valuation Methods Is Right for Your Business?

Now that you have a basic understanding of the seven major business valuations, which method will
you choose for your situation?

First, remember that business valuation is not an exact science, and the method that works for your
friend’s business might not work for yours. What worked for your business in the past might not
even work for you now. Factors like the size of your business, your growth rate, your industry, your
stability, your profitability, and the reason why you need a valuation in the first place will all affect
which method you choose. 

Whether you’re a tiny small business or big small business, a new business or a well-established
business, you’re likely to find your best method of determining your business’s value in one (or
more) of these seven options. Also regardless of your business’s situation, you should absolutely
hire a business valuation expert. That way, you’ll get the most accurate possible calculation of your
business’s worth.