More business owners than ever before are preparing their companies for a good exit and one of the primary questions many are asking is how to value their business. Multiple methods exist to suit the various kinds of businesses operating today. The most common valuation calculation method is found by taking a multiple of EBITDA to Adjusted EBITDA.
EBITDA = net income +( interest + taxes + depreciation + amortization)
Calculating Adjusted EBITDA
To Calculate Adjusted EBITDA, you take your EBITDA calculation, add back expenses that the new owner will not incur (owner's personal expenses, owner's salary) then deduct the amount for the new cost of running the business (new CEO salary). Then use the table below and apply a multiple to the calculated adjusted EBITDA.
1. Net income
You probably know your net income already. This is your company’s income minus the cost of goods sold, expenses and taxes. To get your adjusted EBITDA, start by adding your taxes, depreciation and amortization to your net income.
2. Other adjustments
These are any one-time expenses or income that the new owner is not likely to incur. For example, if you built a new plant this year add what you spent on it back to your EBITDA, because the new owner is probably not going to build a new plant every year.
3. Cost to the new owner
This accounts for the changes in cost to the new owner. For example, if your son has been helping you out at the business and isn’t on payroll, the new owner will need to hire someone to replace him. You’ll need to subtract the salary the new owner will have to pay your son’s replacement. Or if you’re taking a $1 million salary and the new owner will hire a president to do your job for $200,000, you’ll need to add the difference between these two numbers.
4. The appropriate multiple
Once you’ve added the costs for the new owner, multiply the result by the correct multiple. This multiple is determined by the size of your business. If your EBITDA is:
- Less than $500,000 multiply by 3
- $500k to $1.25 million multiply by 4
- $1.25 to $2.5 million multiply by 5
- $2.5 million or more multiple by 6 and up
The result is a reasonable estimate of the value of your business for most manufacturing, distribution and service businesses. These multiples do not apply to hi-tech or software firms.
Speak with an expert about transitioning your business.