CapitalPitch Blog

What Part Does Revenue Play in Business Valuation?

[fa icon="calendar"] 07/06/2017 10:30:00 AM / by Alan Beattie

Alan Beattie

Do you know how much your business is worth?
This is, without a doubt, one of the most important considerations you will have as a founder; in fact, according to Quickbook, "valuation is the single most important concept in finance, and it's something that every business owner should know something about." If you want to be an entrepreneur, you need to understand the art of valuing your company. 

"Knowing what your business is worth is important when making financial decisions such as whether to expand or sell the business. If you are pursuing financing, the business' value will be of great importance to potential investors."

K.A. Francis

The truth is, business valuation is important even if you aren't selling your company. For instance, valuing your business is a key factor when it comes to raising funding, be it Seed, Series A or beyond. If you are looking to raise money for your business, any venture fund or potential investor will need to know what your company is worth. One particularly significant consideration when determining the value of your business is not only the amount of revenue that your company brings in, but also the type of revenue. 

With this in mind, let's take a look at what part revenue plays in business valuation and how to correctly determine revenue. We hope you find this a helpful and informative resource when it comes to raising funding for your early stage business venture. 

the importance of business valuation to a company

What's your revenue?

When it comes to your business' revenue as part of the valuing process, you may think that it is simply a matter of pulling the numbers from your tax return. But if it were that easy then you wouldn't need to be reading this, right? The truth is, investors are going to be interested in a different number, the make-up of that number, and the projected growth of the income. There are several aspects to think about: is the revenue recurring, is it one-off, what is the likelihood that the paying cusotmer's subscription will be renewed, what is the spend required to generate the revenue, how flexible is the pricing strategy, is upselling possible? There is a lot to think about and to understand...

The SDE is important to investors because it provides a more accurate idea of your business' revenue potential which is key in determining the value of your business. An article from the New York Times states it this way:

"If you try to place a value on your business without recasting profit and loss statements, you may understate the cash flow from operations, which could in turn result in an asking price for your business that is too low."

The SDE number is important due to the fact that simply valuing your company based on exisitng revenue can actually lead to significantly undervaluing the business. Why is this? Well, as a small business, you are likely looking to diminish your tax burden as much as possible. The more expenses that you report on your tax return, the lower the revenue you report. 

A better way to value your company is by the seller's discretionary earnings. The SDE is calculated by adding expenses back to your revenue. These expenses would include items such as your salary and perks, any family members you have on payroll, depreciation and amortization or any other non-cash expenses, any leisure activities related to running the business, charitable donation, personal expenses that are related to the business and any non-essential business travel. Calculating your revenue in this manner will raise your net income, giving a better representation of your company's worth. 

SDE Multiplier

The next step to valuing your company is to find the SDE multiplier. The thing about businesses is that they sell for more than the seller's discretionary earnings, 1 to 3 times more. The trick is to figure out the right SDE multiplier to accurately value your business. There are a number of variables involved in calculating this. Factors such as industry, market risk, assets, the size of your company and owner risk all come into play. It is advised that you consult either an appraiser or a business broker for help when it comes to estimating the SDE multiplier. 

Business Assets and Liabilities

Now that you have figured out the SDE multiple, there are a couple of other factors that have not yet come into play. These factors are your business' assets and liabilities. 

First, you will add your assets. This will include such things as intangible assets like reputation and goodwill. You will also want to consider tangible assets such as inventory real estate, cash on hand and any asset not included in the SDE multiple. 

Finally, subtract items such as interest payments and debts and anything else that might be considered a liability. Once you have followed all these steps correctly, you will come up with your business' estimated value. Congratulations, you are one step closer to funding your business venture!

Online eValuation

Determining the value of your company can be difficult and having the best tools at your disposal can be of great value to you. This online eValuation tool can be immensely helpful. With the correct information on hand, this is a quick and efficient tool for calculating the value of your company. Having tools like this available to you will go a long way in saving you time and headache and will make your life a whole lot easier in the long run. 

Capital Pitch is in the business of raising funds for startups. Our team of accredited, professional investors can assist you in raising capital for your business venture. If you would like to know more about what Capital Pitch can do for you, please contact us today. We look forward to making your business dreams a reality. 

 

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Alan Beattie

Written by Alan Beattie

Currently I am investing in/advising several technology and financial start-ups and businesses in Australia, and developing ways to assist in closing the early VC funding gap that exists for such businesses.