How do you value a com­pany when there’s no pub­lic mar­ket to gauge price, espe­cially for small busi­nesses? It’s not like you can input a bunch of num­bers and vari­ables and spit out a price. It’s really worth what some­one is will­ing to pay for it; which often means how much a buyer can afford, and what the return on their invest­ment will be.

You can wait to set the price when an owner, ex-spouse, ben­e­fi­ciary, or a depart­ing owner exer­cises a right to pur­chase. But this approach often ends with dis­putes and lit­i­ga­tion. That’s no way for a trans­ac­tion to hap­pen. There’s a num­ber of other ways to set the price. Don’t just pick one and stick with it through­out the life of the com­pany. You’ll want to adjust it as the com­pany grows. You could base the price on cap­i­tal accounts, but they don’t bear any rela­tion­ship to the real worth of business.

You could base the price on a fixed price. That’s seems easy enough. It’s kind of like look­ing at the price tag on a prod­uct. This method might be a good can­di­date for a ser­vice busi­ness, a com­pany in its first year, or a closely held busi­ness. But the value of a busi­ness fluc­tu­ates. What­ever price you choose will quickly be out­dated. If you decide to go this route, then make sure to update the price every year or so. But most peo­ple for­get to do this.

The other way to set the price is based on a for­mula. Here are a few to consider.

Book Value

This sounds easy enough; just check the bal­ance sheet and you’re good to go. But this for­mula doesn’t account for intan­gi­ble assets like rep­u­ta­tion and good­will. In some cases that’s okay. It works well if you’re just start­ing out or are mar­gin­ally prof­itable in a highly com­pet­i­tive busi­ness. It doesn’t work well for a prof­itable, mature com­pany. If you go this route include a sam­ple bal­ance sheet to show how the book value is calculated.

Mul­ti­ple of Book Value

If you’ve built up some good­will, have a pos­i­tive rep­u­ta­tion, or have a valu­able asset such as a good lease, you can set the price at a mul­ti­ple of book value. This might work for com­pa­nies like a retail busi­ness and other com­pa­nies not in the per­son­al­ized ser­vice sector.

Mul­ti­ple of Earnings

This method takes the aver­age of yearly earn­ings (three years is a good num­ber) and chooses a mul­ti­plier. This method works well for busi­nesses that have oper­ated for a long time, have con­sis­tent prof­its, and have a good future. The mul­ti­plier depends on the indus­try, but nor­mally is not higher than three. If you’re one of those lucky busi­nesses with great earn­ings, a niche, and a solid cash flow, you might be able to go as high as ten.

Appraised Value

This method is sim­ple. You hire a pro­fes­sional appraiser who decides the value. Or the buyer chooses an appraiser and the seller chooses an appraiser who each come up with a value on their own. If each of their appraisals are dis­parate, the two apprais­ers hire a third appraiser to pro­vide the final value. This approach can be really expen­sive and take a lot of time. Since it’s more art than sci­ence, it can also be sub­ject to dis­pute. It’s really only good for a com­pany whose main asset is real property.