How to Value a Business: Forget About Your Net Profit (Data Study)
Updated on September 15, 2021
Business valuing is both simple and complex at the same time. The concept is simple: you analyze your business’ performance and history and give it a monetary valuation figure. But the actual analysis is the complicated part.
Before we get into that, let’s first look at what a business valuation actually is.
Your business is an asset like any other, stocks, property, cryptocurrency, etc., and the value of the asset is based on how it performs. A business valuation determines the monetary value of your business as an asset. Don’t be fooled into thinking it’s just about how much money the asset makes, however; business is a bit different.
For an asset like stocks or cryptocurrency, the investor doesn’t really have any control over how they perform. For a business, however, the investor is taking ownership of the asset, and by maintaining and improving its performance, they can influence the return on investment (ROI).
The buyer of your business therefore needs to know they have the skills (or know who they can hire with the necessary skills), resources, and capital needed to grow your business, and your business needs to have the potential for growth. These are some external valuation factors that a buyer will consider when valuing your business. We’ll discuss the performance-based metrics that go into a valuation shortly.
With all these factors at play, how do you determine the value of your business?
Many people begin by looking at their monthly net profit. They then find businesses that are bringing in similar revenue and conclude that their business should have a similar value.
But while net profit is the main factor we consider when valuing a business, it isn’t the only factor.
This is why we conducted this study. We wanted to find out whether comparing your business to others in order to determine its value is a good strategy. In order to do so, we looked for correlations in the data between net profit and the final sale prices of businesses.
If you want to find out the value of your business, then you check out our valuation tool here. It takes into account multiple aspects of your business to give you an accurate estimate as to what it’s worth.
Net Profit Vs Sales Price – What Does the Correlation Look Like?
In this study, we looked at the sales of 70 businesses within the $99K to $205K range, and compared how much monthly net profit the businesses were making with how much they sold for on our marketplace.
To do this, we separated the 70 sales into specific price brackets, as you can see on the x axis on the graph below. We looked at the net profit differences between 8 businesses that were sold within the $99K to $101K range, between 6 businesses that were sold within the $109K to $111K range, and so on.
You’ll notice that as the price brackets approach the $205K mark, they get wider. This is because the larger businesses get, the prices they sell for ranges more. For example, between the $99K to $101K range we have sold eight businesses, whereas within the $149K to $151K range we have sold only three businesses, so we had to accommodate for this by increasing the size of the price brackets to make the data sets more even.
What the Data Showed – It Might Surprise You
First up, we have the difference in monthly net profit. Within each price bracket ($99k – $101K, etc.), the businesses sold had different monthly earnings. The graph below shows the difference in profit in dollars between the lowest-earning business and the highest-earning business within each of the price brackets.
If we look at the first price bracket, $99K to $101K, the highest-earning business was making $5,759 more per month than the lowest-earning business. Despite this, the difference in the sale price between the two businesses was no more than $2K (we’ll look at the actual sale price difference in a moment).
In this example, the lowest earning business was making $2,776 a month while the highest earning business was making $8,535 ($8,535 – $2,776 = $5,759).
Can you start to see how monthly net profit should not be the only metric you consider when valuing your business? You’d think a business earning $8,535 a month would sell for way more than a business earning $2,776 a month, right?
As the data shows, this isn’t always the case, as we’ll discuss later in the article.
Let’s compare the differences between the average annual net profits for the highest- and lowest-earning businesses.
Again, taking the $99K to $101K price bracket as an example, the lowest earning business was making $33,312 on average in annual net profit, while the highest earning business was making $102,420 – over 3x more.
So, what was the difference between their sale prices? For this example, the highest-earning business sold for $69 more than the lowest-earning business. You might wonder whether this is true in general – did the highest-earning businesses within each sale bracket sell for more than the lowest-earning businesses?
Not always.
The graph above shows the sale price difference between the lowest-earning business and the highest-earning business within each price range.
The blue bars indicate cases where the highest-earning business sold for more than the lowest-earning business. The red bars indicate cases where the lowest-earning business sold for more than the highest-earning business.
Remarkably, the data shows that there are businesses that were earning less but sold for more; sometimes up to $5K more as shown in the $128K to $135K price bracket.
You can see the variation of both profits and sale prices in the combo chart below:
If you look at the $128K – $135K sale price range in the chart above, you’ll see that despite earning $2,387 less than the highest-earning business, the lowest-earning business still sold for $5,000 more. Even when a higher-earning business sells for more than a lower-earning business, the difference in sale price doesn’t necessarily correlate with the difference in earnings. For example, if you also look at the $158K – $165K price range, you’ll see that despite earning $3,895 more a month (over $45,000 more a year) than the lowest-earning business, the highest-earning business only sold for $5,000 more.
You’re probably thinking, this doesn’t make sense, right? Why would someone pay $5,000 more for a business that is earning $2,387 less?
It’s because there are more factors involved in determining the value of a business than just the net profit, which we’ll list out later in the article. Sometimes a business buyer is looking for a certain business model in a specific niche to supplement the growth of one of their current businesses, so the earnings of the business to them is secondary.
Before we dive into the valuation factors that a buyer considers, we had one anomalous result in the study that raises an important point. A business that was listed for $500,000 that sold for $150,000 – a difference of $350,000. This is not very common, but it does happen.
If the seller of the business doesn’t maintain its performance while it’s listed on our marketplace, then traffic, earnings, and other value metrics can drop significantly. A business can also get hit with a huge blow, like a Google or Amazon update, which can sink its profits almost overnight.
This is why it’s important to run your business as normal while it’s listed for sale and to diversify your traffic and earning revenues so you can mitigate the effect of external factors on your business.
Businesses can sell at prices different from their initial valuation for multiple reasons. If a seller wants a quick sale, they’ll usually accept less than their business’ list price. It’s also not uncommon for business value to change while on our marketplace, too. If profits increase significantly, then we’ll update the listing price to reflect that. Also, if a seller agrees to an earnout – a deal whereby the buyer of the business agrees to pay a portion of the money upfront, then pay the rest at a later date – this can also affect the final sale price as they may want to be paid more in exchange since they have to wait for the full payment.
While it may seem as though net profit isn’t the most reliable measure when it comes to valuing a business, we still consider it the most important factor given that, typically, the more a business earns, the more it should be worth. What this data indicates is just that higher profit is not always correlated with higher sale price, and so, while it is important, it shouldn’t be the only factor you consider when valuing your business.
Lessons We Can Learn From This Data
There is a reason we look at more than just monthly earnings when we value a business; it doesn’t tell the whole story of a business as an investable asset.
At Empire Flippers, we believe that every business is unique and should be valued accordingly. As a result of our experience selling over $150 million of online businesses on our marketplace, we understand what buyers want, and we consider a range of factors to understand the whole story of your business. These factors can be categorized as follows:
- Fundamentals:
– Business model
– Business age
– Time required to maintain the business - Growth/decline:
– Consistency of profit (we usually calculate a 12-month average)
– Monthly recurring revenue (MRR) and annual recurring revenue (ARR)
– Website/store traffic - Diversification:
– Sources of income (how many and how consistent the earnings are)
– Traffic sources (how many and how consistent the traffic is)
– Number of connected affiliate networks
– Number of connected advertising networks - Defensibility:
– Number and quality of reviews
– Replicability of the product
– Uniqueness of the brand
– Ranking in Amazon and Google for hot keywords
– Social media following
– Brand presence in the niche - Business assets:
– Products
– Trademarks
– Quality of domains
– Number of employees
– Supplier contracts
– Email subscribers
– Social media accounts
– Active customers (SaaS & subscription)
When a buyer conducts due diligence on your business, they’ll likely have their own list of valuation points they refer to when determining whether to buy your business. This is different for every buyer. Some only want a business that is consistently growing, while some look for businesses that are declining so they can fix the problems, increase profits, and make a quick ROI.
This is a lot of information to consider, and for someone who is new to selling a business, it can be overwhelming. That’s where a business broker can help.
How a Broker Can Get You More Money for Your Business
As an industry-leading brokerage, we can safely say that using a broker can help you get more money for your business.
Valuation is a fine art.
Value your business too low, and you won’t get the price you deserve. Value it too high, and buyers will see you’re inexperienced and negotiate you down to a price that is lower than your business is worth.
This is why using a broker who has experience making hundreds of online business deals with the world’s largest curated online business marketplace can help you get the payday you deserve.
We have a whole team dedicated to valuing your business, as well as a marketing team to promote your business to our pool of buyers, who, at the time of writing, have over $11.3 billion in available liquidity to purchase businesses, a sales team to help you negotiate the right price with trustworthy buyers, and a migrations team to transfer your business over to the buyer for you.
Just like hundreds of online business owners before you, you can trust us to get you the right price for your business on our curated marketplace.
Click here to list your business for sale and one of our vetting team will be in touch. Listing your business is free and allows you to continue earning while we sell it for you. If we don’t sell it, you pay nothing!
Or, if you’d like guidance on how to prepare your business for sale, set up a free call with our friendly exit planning team to get all your questions answered.
