How to Value a Business

Valuing a business is complex. Experienced practitioners have
written novels on the subject, but we don’t have time for that here.
Instead, this represents a high level crash course in business valuation
using the “EBITDA multiple” method, which is the most common valuation methodology used by private equity firms, strategic buyers, etc.

Q: How are businesses similar to homes and baseball cards?

A: They are all worth what the highest bidder is willing to pay for
them, no more – no less, regardless of what any book says. As a result,
businesses are typically valued based on sale prices of comparable
companies (“comps”). Just as homes in your neighborhood of similar size
represent a “comp” for your home, a business comp is roughly defined as
another company in your industry, of similar size and similar cash
flows.

Valuation Step 1: Calculate EBITDA:
The most basic reason companies have value is because they generate
cash; they are an investment that returns cash. The starting block of
every company valuation is calculating its cash flow, or “EBITDA”.
EBITDA is a quick & dirty estimate of the company’s free cash flow;
the pool of cash generated by the company’s normal operations, available
to make investments and service debt after all other operating expenses
have been paid.