Understanding How to Value a Privately Held Business
Valuing a privately held business involves more complexity than assessing a publicly traded company. Public companies are often evaluated using straightforward metrics like the price-to-earnings (P/E) ratio. However, privately owned businesses require a deeper dive into their financials to determine their true profitability. Here's a closer look at the process.
Valuing a privately held business requires a detailed approach, unlike publicly traded companies that can be evaluated using metrics like the price-to-earnings (P/E) ratio. The first step is analyzing the company’s profit and loss (P&L) statements from the past three years to uncover its true profitability. This includes identifying non-recurring expenses and costs that may reduce taxable income but benefit the owner personally.
The process begins with EBITDA (earnings before interest, taxes, depreciation, and amortization), which is then adjusted by adding back certain expenses—called “add-backs”—such as the owner’s salary or personal use of company vehicles. These add-backs are verified with the business owner and added to EBITDA to calculate seller's discretionary income (SDE), reflecting the business’s true earnings.
Finally, privately held businesses are typically sold for a multiple of SDE. The right multiple depends on factors like the company’s operating history, profit stability, and customer concentration. By considering these elements, a business owner can determine an accurate value, setting the stage for a fair sale price.