How to value a service business
March 15, 2023 ⋅ 13 min read
If you are planning to acquire a service company, sell a service business or pass down the business to a family member, it is crucial to determine its market value first. Conducting a business valuation is an efficient way to assess the financial health and potential of a company you own or a business you plan to acquire. This blog discusses the various methods on how to value a service business and its benefits.
Baton connects you with the expertise you need to get the precise value of your company. We provide a standard for business valuations, powered by actual financial data. You can use Baton to track your valuation over time, estimate the impact of changes to your business, find the right buyer when you’re ready to sell, and more.
What Is a Service Business?
A service business refers to any enterprise that provides services to customers. Unlike primary and manufacturing companies, service businesses do not extract raw materials or create goods.
However, like the other industries, they add value to the trade of products and contribute to the country's overall economy. Examples of service businesses include landscaping, warehousing, plumbing repair companies, banks, computer services, consulting firms, law firms, auto mechanical businesses, and many more.
What Is a Business Valuation?
Business valuation is the process of determining the economic value of a business. In a service business, valuation considers many factors, including client base, business reputation, physical assets, equipment, lifetime value of clients, and much more.
Although business valuations are mostly done for the purpose of preparing for the sale or acquisition of a business, they can also be done to fulfill other purposes, including taxation, divorce, inheritance, or because the owner is curious and wants to plan for retirement. The business valuation process leverages various methods depending on the specific goals of the process.
Why Are Business Valuations Important?
A business valuation provides precise facts and figures regarding the actual worth of your service company. Once you have valuable insights, you can make better decisions on the performance and growth of the business.
The following are the key benefits of business valuation:
A business valuation report is a prerequisite if you consider bringing investors on board to fund the business growth. Potential investors need to see where their money is going and how they will recoup a handsome return on their investment. Since a valuation provides the current and future value projection, the process is a smart way to convince investors to inject their money into your venture.
Helps with decision-making
A business valuation provides vital insights into factors that positively or negatively impact the performance of a business. The process helps you make informed decisions on improving performance and increasing the business' overall value.
Aids the selling process
Selling your service business is a significant life event. You have put a lot of time and resources into your business, which is crucial to ensure you get the best returns. The only way to price your business right is by knowing its worth. Besides, prior knowledge of the company's value helps you identify the aspects that could increase the value of the business, so you achieve a higher selling price.
Greater knowledge of company assets
As a service business owner, it is important to assess the business assets accurately. Working with estimates is unacceptable because it is viewed as a generalization. Determining the correct number and value of company assets makes prudent decisions on how much to reinvest into the business and how much to dispose of.
Higher bargaining power during mergers and acquisitions
If you are planning to bring investors on board, you should show them the value of your business, how the company has grown, and the future growth projections. Interested parties usually strive to acquire your business for much less than it's worth, and without a business valuation report, it becomes difficult to bargain for a better deal. A business valuation reveals a consistent trend in value growth which can help you negotiate a better purchase price.
Crucial when planning for retirement
Having a business valuation sets the stage for effective retirement planning. A valuation provides the owner and their retirement planning team with a complete snapshot of the owner’s wealth. Besides, you gain crucial insights into your company’s value to help you devise strategies to increase its value and achieve the target you need to retire.
How to value a service business: Valuation methods and approaches
There are several valuation methods to determine the worth of your service business. Depending on your specific situation, one method may be more beneficial than the other. Thankfully, you don’t have to be an expert on all of the valuation methods. Baton is here to help you choose the most ideal method for your business. If some of the valuation methods you are considering are confusing, our experts are ready to help.
The following are the common business valuation methods to consider.
Seller's Discretionary Earnings or SDE is one of the most common metrics used to value a service business. SDE represents the full financial benefit your company would provide to a single full-time operator. SDE is calculated by taking a service business' net profit and adding specific discretionary expenses.
The discretionary expenses comprise the owner's salary, payroll taxes on the owner's salary, depreciation, interest, and all personal expenses the business pays. SDE is used to value small businesses where the owner actively works in the business. This approach gives potential buyers a clear view of how much they would make should they decide to work full-time in the business.
The Fair Market Value Valuation Method
The market value valuation approach determines the worth of your service business by comparing its value to the value of similar companies that have sold. It is the most subjective method that works well for businesses that can access adequate market data of their competitors.
For this reason, the market value valuation approach may not be difficult for small businesses because it is difficult to find comparative data on the sale of similar businesses. That’s why you can work with Baton - we have a database of over 4 million businesses with valuations, historic sales, and more to value your business.
Determining fair market value: Factors that affect FMV of your business
Several factors can affect the fair market value of your business. These include the business type, the book value, current income, dividends, and recent prices paid for comparable prices. For this reason, the difference between the fair market value and the actual purchase price is often considerable.
To get the best price, consider hiring a professional appraiser for the business valuation process. At Baton, our highly experienced appraisers use multiple approaches to evaluate the FMV of your company. Our goal is to help you gain a true picture of the worth of your business.
During the assessment of your business, the appraiser focuses on the following items, among many others:
An appraiser forecasts the future earnings of your service business over a specified number of years while factoring in residual discount value and discount cash flow. The discount rate reveals the diminishing value of the money over the covered number of years.
Comparable sales figures
The appraiser will then analyze recent sales of similar businesses.
Partial purchase discount
If you are selling a minority share of your business, consider applying a discount because the other party will gain some control of the business.
Asset-Based Valuation Method
For some businesses, you may want to value the assets. This approach takes the net asset value of your business minus the value of its liabilities as per your balance sheet. Keep in mind not every valuation uses an asset-based method since those assets are usually crucial to producing the SDE. The asset-based valuation is useful with assets like a used car dealership that uses a blue sky method or liquidation.
Total net asset value - total liabilities = asset-based valuation approach
You can approach the asset-based valuation method by using the liquidation value.
The liquidation value asset approach is used when planning to liquidate the business. In this scenario, the value is determined by the net cash you obtain after terminating the business and selling its assets. In a nutshell, the liquidation approach figures out how much cash would be left after the business sells all its assets and pays off its debts. With this formula, the value of business assets is typically lower because liquidation often offers a much less than fair market value.
ROI-Based valuation method
An ROI-based valuation approach is often used when seeking investors to buy into your business. The method determines the value of the company based on the business' profit and the return on investment that a buyer will potentially recoup after buying into your service business.
The ROI is determined by calculating the net profits and then dividing the profits by the costs. For example, if you have $200,000 in net profits and $500,000 in costs, the ROI will be 40%.
Discounted Cash Flow Valuation Method
The discounted cash flow (DCF) valuation method or income approach uses predictions of future cash flows. The first step to getting the value of your business using this approach is to discount the cash flow. This means applying a discount rate that calculates the current value to cash flow to determine how much they would be worth in current dollars.
This approach is ideal for businesses with future variable income. When using this approach, it is advisable to work with a business valuation expert that incorporates the DCF method to determine your business' worth quickly, like Baton
How Can I Value My Business at Different Stages In Its Growth?
When determining the value of a business, growth is often taken into account. However, valuing a growing business can be challenging.
Experts recommend using a discounted cash flow (DCF) valuation, especially for businesses whose organic revenue growth exceeds 15% annually. DCF typically works where other methods fail since the main principles of economics and finance apply even in a fast-changing environment.
How Can I Value a Service Business Quickly?
The fastest way to value a service business is by using the multiple of earnings method. This approach involves finding your discretionary earnings that are likely to occur soon and using a multiplier of between 0 and 5.
To determine the multiplier to use, consider that most small businesses are sold for about 2 to 3 times the discretionary earnings. Ideally, the amount over discretionary earnings is the value of the tangible assets the business needs to run, including equipment, fixtures, and inventory.
That being said, a lot of factors go into finding the appropriate multiple. Baton can help – you can get a valuation for your business in less than 10 minutes.
Can Hiring an M&A Broker Help You Sell Your Service Business?
Getting the best buyer for your service business could require a marketing strategy to ensure you attract as many qualified purchasers as possible. The entire exercise takes a lot of time, effort, and expertise. This is why you may want to hire a skilled and experienced mergers and acquisitions ("M&A") advisor or business broker for this process.
The broker can help create a market for your company via a competitive process to help optimize the sale of your venture. With an advisor handling the heavy work, you can focus more on essential operations than marketing your business to potential buyers. An experienced broker will help you avoid typical mistakes and guide you through the sale's negotiation, due diligence, and closing stages.
How Baton Can Help You Conduct a Detailed Businesses Valuation
As discussed above, several different methods of valuing a service business exist. The best one for you and your business depends on several factors, including the expected income, company assets, and how much the market is likely to pay based on comparable sales.
The valuation experts at Baton use a combination of methods discussed above to arrive at an unbiased, accurate valuation that considers your business' unique details. Contact our valuation experts today to get started in just 10 minutes.
How to Increase Business Value in a Service Company
No matter the current worth of your business, it is possible to increase its value with prudent planning. The following are just a few strategies to increase the value of your venture over time:
Plan for market dynamics
Always consider potential market volatility and the likely impact on your business. Economic downtimes can adversely impact your business, including reduced revenues and difficulty finding new customers and investors. Staying on top of market dynamics can help you implement sound strategies to ride out storms when they happen.
Improve cash flows
Strive to improve your cash flow as much as possible. Consider putting limits on customer credit to help boost your business cash flow. You should also keep an eye on inventory to determine the products in high demand. Finally, find ways to generate more cash-producing revenue for your business.
Diversify customer base
Customer concentration ultimately reduces the value of your business because investors regard it as a risk. Diversify your customer base to reduce the risk of losing revenue should a handful of clients take their business elsewhere.
Improve customer service
You can enhance brand loyalty and a diverse customer base by offering better customer service. This, in turn, benefits the value of your business.
Create an exit plan soon enough
If you are planning to sell your business, don't wait until the last minute to create a business exit plan. No matter the age of your business, it is never too early to think about exiting it and how to fund your retirement. At Baton, our experts are ready to help you determine how much you will have in retirement once you sell your small business.
Seek advice from an expert
Seek the help of experts to improve the value of your business. Business valuation professionals from Baton will help identify operational inefficiencies that weigh down your company's value. They will also implement more robust cash flow strategies to enhance the value of your service business.
Baton Can Help
Understanding the value of your service business is crucial regardless of future plans. Whether you have thought of liquidating the company or bringing on board more investors, it is never too early to start planning.
The only way to understand the worth of your business is by learning how to value a service business. The valuation experts at Baton are happy to help you with the entire process.
We will also help identify ways to increase the value of your service business. At Baton, we leverage a combination of valuation approaches to determine the accurate value of a service business. Our goal is to provide quality business valuations and appraisals to help you make sound decisions and craft robust strategies. Find your business, get a valuation today, and connect with a Baton business advisor. If you have further questions regarding business valuation, you can learn more today.