How Much is My Business Worth?
The valuation of a business is determined by how many years into the future that business would produce the same or better profits in the absence of the founder(s).
Another way of thinking about this is that the value of a business empirically speaking in real numbers, comes from forecasting.
How many years into the future?
Do you think this year’s earnings are likely to repeat?
As an example, you have a money machine prints $1 and you feel confident that this machine, exactly as it is, will at least produce that same dollar for 10 years in advance.
You’re willing to pay $10 for it now, knowing that after 10 years, you will have broken even on that investment. The term for this is called a multiple.
The multiple a company is valued upon is essentially the number of years into the future that is safely believed that business will conservatively provide this year’s profits over and over again.
If you have never heard of this or have been taught this, it’s a change in thinking.
It’s a different mindset, which is part of what we’re trying to do here is help you think like a real 8-figure entrepreneur.
So, if I have a $1 machine and I believe that it will last five years, then that is a multiple of five.
And it’s saying I am willing to pay $5 today for the money machine that prints $1.
That’s a multiple of five.
I’m going to pay you five years of profit all upfront now in exchange for you giving me your money machine.
And after five years, if nothing else improves and there are no other synergies, then every year afterward, I will be making money that I would not have been making otherwise because you built the machine, but I bought the machine from you.
And now all the money is in the future stream of cash flow. Every dollar after that fifth year is profit in my pocket that I gain as the result of the risk of my paying you $5 upfront for a machine that only prints $1.
The fancy business term here is EBITDA, which is an accounting term. It’s an acronym.
It’s a simple concept, but people get lost in fancy business terms.
It stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
What in the heck does that mean?
If you’re not an accountant or if you are not familiar with accounting, you probably don’t know much about interest in taxes and depreciation and amortization.
Those are all accounting terms and EBITDA means profits.
Your EBITDA is a dollar in profit.
Of course, in reality, when you do all of the work, take risks and hustle, putting your life savings on the line, and investing blood, sweat, and tears into your business, when you make the money, the government’s going to take an enormous cut of that right out of the gate.
And you’re going to have to pay interest to banks and anyone that you took loans from, and you also have to pay off assets that you used to build the business.
All that stuff eats into your profits, but for this article, that’s just what EBITDA is: profits.
Business Valuation Formula
So, when you’re considering what a company is worth, this is how it works mathematically.
It’s EBITDA (profits) times the multiple (estimated number of years the profits will continue).
My money machine prints $1, and I think that that machine is going to last at least five years, and I’m willing to pay you a multiple of five, then that gives me my value, which is $5.
$1 profit times a multiple of five.
That’s the valuation of the company.
I will pay you $5 today for your money machine that prints $1 every year.
That’s how value is derived. It is a calculation.
It is an empirical calculation of how businesses are bought and sold.
What do you think about this mindset? Comment below.