Top Valuation Methods for SMB Buyers

Purchasing a small or medium-sized business (SMB) requires knowing its true value. Many owners don’t, which creates risks and opportunities for buyers. Here’s a breakdown of the three main valuation methods:

• Asset-Based Valuation: Focuses on the company’s assets minus liabilities. Best for businesses with significant physical assets but overlooks future earnings.
• Income-Based Valuation: Estimates value based on future earnings potential. Ideal for businesses with steady cash flow but requires accurate financial forecasting.
• Market Comparables Analysis: Uses recent sales of similar businesses to estimate value. Useful for industries with frequent transactions but limited by data availability.

Using all three methods together provides a clearer picture of a business’s worth. Tools like Kumo can simplify the process by offering access to aggregated listings and financial data, helping buyers make informed decisions.

How to Value Your Business and Sell It - 3 Methods of Business Valuation

1. Asset-Based Valuation

Asset-based valuation offers a practical way to assess a business's worth by focusing on its tangible and intangible assets. This method calculates value by subtracting total liabilities from the fair market value of total assets. While straightforward, factors like depreciation and market shifts can influence the final figure.

Two Core Approaches

• Going Concern: This approach assumes the business will continue operating, calculating the net value of assets and liabilities as they appear on the balance sheet.
• Liquidation Value: This method estimates the net cash value if assets were sold and liabilities paid off, often resulting in a more conservative valuation.

Best Use Cases for Asset-Based Valuation

This method shines for businesses with substantial tangible assets, such as those in manufacturing, construction, or transportation. It's also well-suited for mature companies with stable operations and significant accumulated assets. However, it may fall short for high-growth or service-focused businesses, as it doesn't account for potential future earnings.

Gathering the Necessary Data

A thorough asset-based valuation requires detailed financial records spanning three to five years, including:

• Financial Statements: Income statements, balance sheets, and cash flow statements.
• Tax Documents: Tax returns for the relevant period.
• Tangible Assets: Records for furniture, fixtures, real estate, equipment, vehicles, and inventory.
• Intangible Assets: Documentation for trademarks, patents, copyrights, brand value, and reputation.
• Legal Documents: Permits, licenses, and contracts.

This comprehensive data collection forms the foundation for an accurate and reliable valuation.

The Role of Experts and Market Analysis

For a deeper assessment, the adjusted net asset method considers off-balance-sheet items like internally developed intangibles. This highlights the value of professional expertise in interpreting data. Regular market analysis and a review of comparable sales also ensure that asset values reflect current conditions.

2. Income-Based Valuation

While asset-based valuation zeroes in on a company's current balance sheet, income-based valuation takes a forward-looking approach, estimating future economic benefits. This method focuses on a business's earning potential by projecting future earnings while accounting for risk, timing, and growth factors. It complements asset-based valuation by shifting the emphasis from present assets to potential future income.

"When using the income approach, valuators attempt to answer the question of how much annual, ongoing economic benefit the business can reasonably expect to produce in the future." - Chad Hudson, Contributor

The core formula for this approach is:

Value = Benefit / Required Rate of Return

Here, the "benefit" refers to cash flow or net income, while the "required rate of return" reflects investment risk, often calculated as a capitalization or discount rate.

Two Key Income-Based Methods

Capitalization of Cash Flow is ideal for established companies with steady earnings. This method applies a single capitalization rate to current or expected earnings to determine the business's value.

Discounted Cash Flow (DCF) works better for businesses experiencing or expecting varying growth phases. The DCF method calculates value by summing future cash flows, which are then discounted back to their present value using a discount rate. For instance, in DCF calculations, terminal value often plays a significant role, sometimes accounting for the majority of a company's total value. This highlights the importance of using conservative assumptions.

Market Multiples and Industry Dynamics

Market multiples can further refine valuations by reflecting trends within specific industries. Recent 2024 data shows that valuation multiples vary widely based on business size. For example:

• The average EBITDA multiple across industries: 6.9×
• Businesses with $1 million in EBITDA: 5.3×
• Businesses with $100 million in EBITDA: 10×

These differences illustrate the inverse relationship between risk and value, where larger, more stable businesses command higher multiples.

Financial Documentation Requirements

Accurate income-based valuation depends on detailed financial records. Typically, this includes 3–5 years of:

• Income statements
• Balance sheets
• Cash flow statements
• Tax returns

Additionally, 3–5 years of financial projections based on realistic assumptions about revenue growth, costs, and market conditions are essential. A comprehensive list of the owner's discretionary earnings is also helpful for adjusting expenses to determine true cash flow.

The Challenge of Normalization

For small and medium-sized businesses (SMBs), adjustments are often needed to normalize non-recurring income and expenses, allowing for better comparisons. Smaller businesses frequently use Seller's Discretionary Earnings (SDE), while larger companies rely on EBITDA calculations.

Item	Amount ($)
EBITDA	170,000
Non-recurring Expenses	20,000
Stock-based Compensation	15,000
Depreciation & Amortization	30,000
Owner's Salary Adjustment	40,000
Lease Exit Costs	10,000
One-time Legal Fees	5,000
Unrealized Gains/Losses	-3,000
Adjusted EBITDA	307,000

Best Fit for Income-Based Valuation

This valuation method works best for businesses with stable and predictable income streams. Service-oriented companies, subscription-based models, and well-established businesses with consistent cash flows often benefit the most from this approach.

However, for startups or businesses with volatile earnings, income-based valuation may need to be supplemented with other methods to achieve a more accurate picture. In DCF analysis, it's worth noting that the terminal value can account for a significant portion - sometimes more than half - of the total valuation. This makes professional expertise critical when forecasting cash flows and selecting discount rates.

3. Market Comparables Analysis

Market comparables analysis estimates a business's value by looking at recent sales of similar companies, considering factors like size, industry, and market conditions. This method provides a practical perspective by grounding valuations in actual market data, complementing asset and income-based approaches.

The process involves identifying businesses with comparable characteristics to the target company and applying valuation multiples from those transactions. As Mainshares explains:

"Valuation multiples is a tool to help standardize the valuation of a business so buyers and investors understand the price they are paying for a unit of financial performance".

How Market Multiples Work

Market comparables rely on standardized ratios derived from real transactions. In small and medium-sized business (SMB) acquisitions, these are the most commonly used multiples:

• EBITDA Multiples: These are the go-to metric for larger SMB transactions. For example, the Pepperdine Private Capital Markets Report found that manufacturing businesses averaged a deal multiple of 7.4×, while the overall average across all industries was 6.9×. Multiples also vary by company size - businesses with $1 million in EBITDA average 5.3×, while those with $100 million in EBITDA average 10×. Larger companies generally command higher multiples due to their stability and lower risk.
• Seller's Discretionary Earnings (SDE) Multiples: These are more common in smaller, owner-operated businesses, where personal and business expenses often overlap.
• Revenue Multiples: These are less frequently used in the SMB space, typically ranging between 0.5× and 2×. However, because they overlook cost structures and profitability, they are less reliable for valuations.

The Challenge of Finding Comparable Data

Using market comparables in the SMB sector comes with significant challenges. Unlike public companies, which are required to disclose financial details, private businesses have no such obligation. This makes data scarce, especially for transactions under $100 million, which often go unnoticed by analysts and media.

Finding true comparables is even tougher for SMBs. As Ori Eldarov points out:

"Comparisons are valid only if businesses are truly similar in size, industry, risk profile, and growth potential".

But this level of similarity is hard to achieve due to fragmented data, limited online records, and the ever-changing nature of small businesses. Add to that the high failure rates in the SMB sector, and establishing reliable benchmarks becomes even more complicated.

Available Data Sources

Given these hurdles, reliable data sources are crucial for applying market comparables effectively. Some of the most trusted include:

• BIZCOMPS: A database with over 17,655 deals since 2000, focusing on smaller "Main Street" businesses.
• Business Valuation Resources (BVR): This includes Pratt's Stats, which provides detailed financial data on more than 18,800 private business transactions. BVR is widely recognized for its accuracy.
• IBBA Market Pulse: This survey gathers insights from brokers and M&A advisors about trends in small business transactions.

Making Market Comparables Work

To make market comparables effective, thorough and high-quality research is essential. The method's success depends on identifying truly comparable transactions and carefully evaluating factors like company size, seller motivation, revenue mix, competition, and industry trends.

Market comparables are most useful when combined with other valuation methods, such as asset-based and income-based approaches. While they offer valuable benchmarks, the lack of standardized accounting practices and limited data availability in the SMB market means results must be interpreted with care.

Small business acquisitions account for nearly three-fourths of all merger and acquisition activity, but the fragmented data infrastructure supporting these transactions makes applying market comparables challenging. This method can yield useful insights, but it often requires professional expertise to navigate its limitations effectively.

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4. Using Deal Sourcing Platforms like Kumo

Modern deal sourcing platforms are transforming how buyers access and analyze transaction data, addressing the challenges of limited information in the SMB sector. Traditional market comparables analysis often struggles with data gaps, but platforms like Kumo are bridging this divide by consolidating business listings from numerous brokers and marketplaces into one centralized database.

Bringing Data Together

Kumo simplifies the hunt for comparable transaction data by pulling listings from thousands of sources. With 815,291 aggregated listings and over $538 billion in deal revenue, it offers buyers an extensive resource that would be nearly impossible to gather manually. At any moment, the platform tracks over 100,000 active deals, with 700+ new listings added daily, providing a real-time snapshot of market opportunities[38,39].

Smarter Analysis with AI

Kumo uses artificial intelligence to streamline the evaluation process. It condenses listings into concise summaries, making it easy to review key metrics quickly. Buyers can filter listings by criteria like asking price, EBITDA, industry, and business type, ensuring they can zero in on businesses that meet their specific needs.

Insights from Historical Data

In addition to current listings, Kumo offers access to historical data, which is invaluable for understanding trends. By tracking changes in metrics and listing details over time, buyers can see how asking prices and business fundamentals shift. This level of detail helps buyers make more informed valuation decisions.

Tools for Seamless Valuation

Kumo includes several features designed to enhance the valuation process. Users can export data to CSV files, save listings with notes, and set up daily email alerts for deals that meet their criteria. These tools ensure buyers stay up-to-date in a fast-moving market[38,39].

Versatility Across Valuation Methods

While Kumo is particularly strong in market comparables analysis, its data is equally valuable for other valuation approaches, such as income-based models. It serves a wide range of users - search funds, private equity firms, family offices, holding companies, and corporate M&A teams - by offering cost-effective access to detailed market data. Importantly, Kumo operates without commissions, referral fees, or success fees, making it an efficient tool for building a well-rounded valuation strategy.

Comparison Table

Choosing the right valuation method can streamline the decision-making process and provide clarity during acquisitions. Each method has its own advantages and limitations, making it more suitable for specific types of businesses and situations.

Valuation Method	Advantages	Disadvantages	Best Use Cases
Asset-Based	Straightforward, objective, sets a minimum value, helpful for distressed companies	Overlooks future earnings, excludes intangible assets, may not reflect market conditions	Companies with significant tangible assets, liquidation scenarios, establishing baseline value
Income-Based	Focuses on cash flow, accounts for risk and growth potential	Relies on subjective inputs, depends on speculative income projections	Well-established or growing companies with steady cash flow
Market Comparables	Reflects current market trends, shows how similar businesses are valued	Hard to find comparable businesses, differences in models can lead to inconsistencies	Industries with frequent transactions and high comparability

Let’s break these down further to understand their strengths and weaknesses.

The asset-based approach is especially useful for businesses with significant tangible assets, such as manufacturing firms or companies with extensive inventory, equipment, or real estate holdings. It provides a minimum valuation that’s easy to calculate but fails to account for intangible assets like brand equity or customer loyalty - factors that often drive the value of small and medium-sized businesses.

On the other hand, the income-based method is better suited for businesses with reliable and consistent cash flows, such as service-based companies. However, its accuracy depends heavily on financial forecasts, which can sometimes be overly optimistic or speculative.

The market comparables method is grounded in real-world data, offering a clear picture of how similar businesses are valued in the current market. As Paul Wormley, Managing Partner at Hadley Capital, explains:

"In nearly every case, a successful company with good cash flows will have an enterprise value that exceeds its asset value."

This approach works best in sectors with frequent transactions and easily comparable businesses. However, it can struggle in niche industries where finding relevant comparisons is challenging.

For the most accurate valuation, combining all three methods often yields the best results. The asset-based method sets a baseline, the income-based method estimates future earning potential, and the market comparables method validates market trends. Together, they help minimize blind spots and provide a comprehensive picture of a business's value.

Conclusion

Getting the valuation right is a key step in successfully acquiring small and medium-sized businesses (SMBs). As Jack Nicholaisen, Founder of Businessinitiative.org, puts it:

"Accurate business valuation is crucial for informed decision-making and strategic planning".

With over 99% of businesses in the U.S. being classified as small businesses, having a solid grasp of valuation techniques is a must for any serious buyer.

The best way to determine a business's value is by using an integrated approach. By combining asset-based, income-based, and market comparables methods, buyers can get a clearer picture of a business’s worth. However, no single method is universally effective. The right approach depends on the specific nature of the business, its industry, and the buyer’s goals.

For buyers, this means tailoring their valuation strategy to fit the unique characteristics of each business. Market comparables, in particular, can provide essential context. For example, small businesses often sell for multiples ranging from two to four times their Seller’s Discretionary Earnings (SDE).

Technology also plays a growing role in valuations. Platforms like Kumo simplify the due diligence process and enhance market-based valuations. By aggregating data from over 120,000 deals across thousands of brokers and marketplaces - and adding more than 700 new deals daily - Kumo gives buyers access to a vast pool of comparable transactions. This wealth of data makes it easier to refine valuations and make informed decisions.

The financial stakes in SMB acquisitions are high, underscoring the importance of accuracy. Due diligence costs alone can range from 0.5% to 2% of the total deal value. Mistakes in valuation, however, can lead to far greater losses. Staying on top of market trends, consulting experts, and leveraging tools like Kumo can help buyers avoid costly missteps and achieve better outcomes.

Ultimately, valuation is a mix of objective analysis and informed judgment. While structured methods provide a foundation, understanding the nuances of a business and its market position requires experience. Investing in sound valuation practices pays off by strengthening negotiation positions, reducing risks, and increasing the likelihood of a successful acquisition.

FAQs

What is the best way to choose a valuation method for buying a small or medium-sized business?

Choosing the right way to value an SMB acquisition depends on several factors, including the business's size, industry, financial condition, and potential for growth. Here are two commonly used approaches:

• Seller's Discretionary Earnings (SDE) or EBITDA Multiples: These methods work well for smaller businesses, focusing on profitability. They’re particularly useful for comparing similar companies or recent sales in the same industry.
• Market Comparables: This approach looks at how similar businesses have recently been sold, making it a practical choice for mid-sized SMBs.

It’s also important to factor in things like industry trends, steady revenue, customer relationships, and the overall economic environment. Often, the most accurate valuation comes from combining multiple methods tailored to the specific business.

What are the main challenges of using market comparables to value small and medium-sized businesses, and how can they be addressed?

Using market comparables to determine the value of small and medium-sized businesses (SMBs) can be tricky. Differences in size, industry, and financial setups often make it tough to find companies that are truly similar. On top of that, outdated or incomplete data and market inefficiencies can lead to valuations that miss the mark.

To navigate these obstacles, try expanding your search to include businesses from related industries or those with comparable operational traits. Adjust financial metrics - like normalizing earnings or revenue - to make comparisons more meaningful. Lastly, rely on a mix of comparable companies to create a more balanced and well-rounded valuation.

How can a deal sourcing platform like Kumo simplify the valuation process for SMB buyers?

A platform like Kumo makes life easier for SMB buyers by bringing together a variety of business listings from different sources, all in one place. This not only saves time but also allows buyers to explore more opportunities without hopping between multiple platforms.

Using AI-powered tools and data analytics, Kumo helps buyers assess critical elements such as market trends, financial health, and potential risks. These insights simplify the valuation process, enabling buyers to make well-informed decisions about acquisitions. By cutting down on guesswork and boosting efficiency, Kumo streamlines the entire experience for SMB buyers.

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