Determining a realistic value for your business is key before going to the market.
Although there are many methodologies to establish the value of a business as a going concern three are prevalent among investment bankers.
1) The DCF (Discounted Cash Flow) methodology is probably the most accurate one.
To apply this methodology the analysts project the unleverage free cashflow using as reference the historical results of the business, the previous and expected growth patterns and any internal and external factors that could affect the future performance.
This cashflow is then discounted at a rate equivalent to the cost of capital which includes a combination of the cost of equity invested by the buyers and the interest rates for the financed portion of the acquisition (WACC), to ultimately obtain a net present value of the company.
This methodology is an effective way of ensuring that the relation between the valuation and the future profitability will be sufficient to give the buyers the expected return on their investment and to repay the loan to acquire the business.
2) The Direct Market Data method involves comparing the value of a business with the value of similar businesses recently sold. To find adequate comparable transactions many elements are considered including the industry in which the business operates, its size, geographical location, etc.
The comparison method is useful, but, on its own, the results may be insufficient as it does not necessarily factor elements specific to the company being sold.
3) The Industry Multiple Rule method is a relative valuation method in which you compare the current value of a business to other similar businesses by looking at multiples on key performance indicators like Revenues, EBIT, Net Income and EBITDA with the latter being the most commonly used.
Valuing a business is a complex task. We have simplified the process somewhat for this brief overview to illustrate how the different methodologies are conducted.