- How Do You Calculate the Value of Your Online Business?
- 7 Ways to Calculate Your Company Valuation
- 1. Multiple Valuation Method
- How to calculate seller discretionary earnings (SDE):
- How to calculate EBITDA
- Which Valuation Multiple Should You Choose?
- How to Calculate Your Online Business Valuation With a Multiple
- When Should You Use the Multiple Valuation Method?
- 2. Discounted Cash Flow Method
- 3. Cost-to-Duplicate Valuation Method
- 4. Berkus (or Development Stage) Valuation Method
- 5. Risk Factor Summation Valuation Method (Similar to Scorecard Valuation)
- 6. Precedent Transaction Analysis Valuation Method
- 7. Use a Free Business Valuation Calculator (SaaS)
- 1. Multiple Valuation Method
- How to Justify Your Valuation to Buyers
Learning how to value your online business can feel exhausting. With so many valuation methods to choose from, how do you know which is the easiest, fastest, and most appropriate for your business? Does valuing SaaS differ from ecommerce, for example?
Whether you’re thinking of selling your business or just curious how much it’s worth, calculating your valuation can help inform your business goals and prepare you for exit. We’ve compiled the most common valuation methods buyers use below to help you determine a realistic number.
Before you continue, however, remember that only a professional can give you the most accurate valuation. We recommend studying these methods, referring to valuation calculators, and then consulting with an expert to ensure you’ve factored everything into your final valuation.
How Do You Calculate the Value of Your Online Business?
To calculate the value of your online business, you need to choose the most appropriate valuation method. The most common are those used by financial buyers when estimating the potential return on their investment in (or acquisition of) a company.
Remember that a buyer will only pay what they believe is fair and representative of the market. That means understanding buyer motivations. Who does your business most appeal to? A financial buyer, for example, acquires your company to earn a return on their investment. A strategic buyer acquires your tech, people, or customers to further their company’s goals.
Strategic acquirers usually pay more, but they’re much harder to find. They’re interested the economic or strategic advantage your business brings to theirs, not financial returns. As a result, it might take several years of preparation just to appear on a strategic buyer’s radar.
Your likeliest candidate is a financial buyer. To them, it’s all about the returns. Think venture capitalists and private equity firms, for example, or a buyer with expertise your business needs to grow. Understanding a financial buyer’s motivations is the first step in nailing your valuation.
7 Ways to Calculate Your Company Valuation
Whether you founded a SaaS, ecommerce, marketplace, or other startup, start with the valuation methods below to demonstrate fair market value for your time, place, and industry.
1. Multiple Valuation Method
The multiple valuation method is where you apply a multiple to one of the following financial metrics:
- Seller discretionary earnings (SDE)
- Earnings before interest, taxes, depreciation and amortization (EBITDA)
If you own and run a small business, you’ll apply the multiple to SDE. This is your profit after deducting operating expenses and cost of goods from revenue but after adding back in your compensation.
How to calculate seller discretionary earnings (SDE):
Use the following formula to calculate seller discretionary earnings (SDE):
SDE = (Revenue – Operating Expenses – Cost of Goods) + Your Compensation
Why add your compensation back in? Simple, if you’re taking the lion’s share of responsibility, you’re probably taking a lion’s share of the profits as compensation and enjoying the capital and tax advantages of being a small business owner. Adding owner compensation into SDE therefore gives a truer measure of earnings potential.
But once you’re big enough to employ a management team, you can’t add your compensation into earnings as you’re no longer the only one running the show. This becomes a real cost and must be left out of the earnings calculation along with your other expenses. Instead, you’ll apply the multiple to EBITDA.
How to calculate EBITDA
EBITDA can be calculated in two ways, and as long as you’re consistent (as in not switching back and forth to get the highest number), you can choose whichever results in a truer representation of your startup’s earnings potential:
- EBITDA = Operating Profit + Depreciation and Amortization
- EBITDA = Net Profit + Interest + Taxes + Depreciation and Amortization
If your EBITDA or SDE is zero because you’re investing heavily on growth, consider applying the multiple to revenue.
For example, it’s pretty common for SaaS businesses to accept short-term losses in return for growth. You might focus on product development and marketing right now, for example, but pull back on these expenses as you scale.
You might also apply a multiple to financial projections, but you’ll need to prove to whoever assesses your valuation you’re on target for such growth.
Buyers might also make your asking price contingent on you hitting projected numbers (called an earnout). Regardless, the multiple influences your valuation the most. And choosing that multiple is where things start to get a little complicated.
Which Valuation Multiple Should You Choose?
Choose a valuation multiple that accurately reflects the potential of your business.
In SaaS, for example, it would reflect your annual growth rate, churn, customer acquisition cost (CAC), lifetime value of customer (LTV), and the quality of your tech stack, people, and upside potential.
To justify a higher multiple, your startup should:
- run by itself or with very little involvement from you,
- have been operating successfully for over a year (the longer the better), and
- demonstrate growth potential.
You might be able to tick points one and two right away. To tick the third, you’ll need to review some success metrics.
Metrics That Can Affect a SaaS or Online Business Valuation Multiple
Churn measures lost income through net customer losses or downsized commitments. It’s an effective measure of customer loyalty and the quality of the product or service on offer, but for it to be meaningful, you should compare your churn rate with those of the industry to assess if yours is better. The better your churn rate (ideally it’ll be negative), the more upwards pressure on the multiple.
- Customer Acquisition Cost (CAC)
Overspending on customer acquisition impacts the value of your business so you want to keep the CAC low. Burning cash to win new customers is a short-lived strategy that often leads to startups failing. Investors don’t want to throw good money after bad, so you’ll need to demonstrate a reason for a high CAC if you want to keep that multiple high.
- Lifetime Value of Customer (LTV)
A high LTV might justify a higher CAC or other revenue losses, and is a useful way of targeting customers who offer the best returns. When deciding what multiple to apply to your earnings or revenue, consider churn, CAC, and LTV in tandem for deeper insight. They each play an important role but combined offer a more complete view of your business’s growth potential.
Multiples can and do vary widely, so refer to our multiples report to guide you. We collect anonymous, customer-generated transaction data to create a report of the average multiples at which startups got acquired. The figures aren’t gospel, but they’re a good start.
When valuing your company with a multiple, buyers tend to look at three things: the quality of your online business, the strength of its performance, and market dynamics. An ecommerce EBITDA multiple, for example, could be anything between 3.1x-14.9x according to one industry report.
Knowing where your startup sits inside that range depends on countless factors: annual growth rate, web traffic, financials, age, customer retention, inventory (if applicable), and lots more. To help justify your multiple to a buyer, we recommend speaking to an acquisition advisor who knows the market.
How to Calculate Your Online Business Valuation With a Multiple
- Decide whether to use SDE, EBITDA, or revenue.
If you own and run a small business, SDE will suit in 99 percent of cases. Choose EBITDA if you’re larger and share operational responsibilities with others, or revenue if you’re projecting massive growth.
- Determine an evidence-based multiple.
Use our average multiples report to establish a range of multiples for similar businesses to your own. Then decide where you startup fits using success metrics like churn, CAC, and LTV (reviewed in tandem) alongside age and operational demand.
- Apply the multiple to your earnings or revenue.
This gives you an approximation you can use to start conversations with buyers. It’s important that you explain how you derived the multiple so that buyers trust the figure. They might challenge your valuation method as a negotiation tactic, but since you’ve done your homework, you are in a position of strength.
When Should You Use the Multiple Valuation Method?
No hard and fast rules exist here, but a multiple valuation assumes you or a buyer can compare your business with others that got acquired. It helps to operate a fairly standardized business model such as in SaaS or ecommerce. You’ll also arrive at a more realistic figure if your startup is at least two years old (proving product-market fit) and generating at least $100,000 EBITDA.
2. Discounted Cash Flow Method
The discounted cash flow (DCF) valuation method is where you discount projected cash flows to their present value.
If someone offered you a million dollars now or two million dollars in five years, I suspect you’d pick the former. You could do a lot with that one million in five years, including investing it to earn a bigger return than that extra million.
Buyers face the same dilemma. How can they ensure that your asking price is a fair reflection of the return they’ll receive in the future? Buyers can answer this question using the discounted cash flow (DCF) valuation method.
Yes, that’s a bit of a mouthful, and the DCF formula is also a little scary-looking. The premise, however, is straightforward: a buyer determines a discount rate to apply to future cash flow that results in its present value. The buyer then compares the present value with your asking price.
The discount rate is the buyer’s expected return, otherwise referred to as the weighted average cost of capital (WACC). If your asking price is lower than the DCF value, your buyer can expect a bigger return. If it’s higher, the expected return is lower so they might drive your price down.
A few caveats: Like a multiple, the discount rate depends on several variables, including the specifics of your online business and the buyer’s investment goals and risk tolerance. It’s also harder to predict future cash flow beyond three to five years. Consider both when using this method.
When Should You Use the Discounted Cash Flow Valuation Methodology?
Any online business with predictable cash flows can use this valuation method. Your buyer has to be confident in your numbers, and it’s up to you to justify them. This could be easy or difficult depending on the complexity of your company and business model.
3. Cost-to-Duplicate Valuation Method
The cost-to-duplicate valuation method values your online business on the financial investment it would take to recreate it.
Startups, for example, are immature businesses. They might not have made any profits or acquired many customers. Some might even be pre-revenue. Financial buyers struggle to value these these startups as scant financial data renders their valuation methods useless.
However, they can calculate how much it would cost to build that exact startup from scratch, otherwise called a cost-to-duplicate valuation. For SaaS, it could be an engineer’s time spent developing the product. In other online businesses, it might involve tallying the cost of tangible assets.
Let’s say you’re a SaaS engineer who’s built a dating app that’s yet to scale. In theory, a buyer can cut their time to market by acquiring your technology instead of hiring someone to build it. So if it took you a year to build the software, you might value your business at the equivalent of an engineer’s annual salary – between $100,000 and $300,000.
In the same way the best seeds don’t guarantee a good harvest, your product or service can’t guarantee a buyer’s return. But that’s not to say your online business lacks value. You might not have the customers or revenue, but you invested your time, knowledge, and probably some savings – and those are worth something.
The cost-to-duplicate valuation methodology gives you and your buyer a starting point. But it doesn’t take into account your growth potential or intangible assets like goodwill, intellectual property, or brand recognition. You might, therefore, want to factor these when calculating your valuation using this method.
When Should You Use the Cost-to-Duplicate Valuation Method?
You can value any startup this way, but it’s probably better suited to smaller, younger, and unproven startups with little to no revenue and few customers. Think MicroSaaS or other businesses with promising products that have yet to find their markets.
The older the startup, however, the less relevant cost-to-duplicate becomes. You might spend ten years building a product or service, but without paying customers, you’ll struggle to convince a financial buyer your startup is worth the equivalent value of your time.
4. Berkus (or Development Stage) Valuation Method
The Berkus or “development stage” valuation method involves measuring the risk factors of an online business split into the following categories:
- Sound idea. Is it scalable, relevant, protected, and proven?
- Prototype. Have you demonstrated proof of concept with a working product or service?
- Quality management. Do you have the skills and experience to grow the business?
- Strategic relationships. How will you leverage partnerships to help you grow?
- Product roll-out or sales. How well can you market your product?
Named after venture capitalist Dave Berkus, this valuation method is mostly used for startups with little to no financial data.
To calculate your valuation, weigh your online business under each category on a scale of $0 to $500,000. Your valuation is the final weighting total. If you score top marks, you might earn a $2.5 million valuation ($500,000 for each risk type). Some financial buyers may widen the weighting scale, too, which could boost your valuation further.
Since the Berkus methodology relies only on qualitative data, it’s an excellent choice when your startup is pre-revenue. The missing piece is financial risk – and it’s a big one. Never value your online business using the Berkus methodology if you’re already bringing in recurring revenue.
When Should You Use the Berkus Valuation Method?
Choose the Berkus valuation method if you’re pre-revenue or otherwise at an extremely early (seed) stage of your business, with little to no financial data available. Qualitative valuations are more like educated guesses, and if you can forecast financial data, you’re better choosing a quantitative methodology or a mixture of both.
Dave Berkus himself said, “I must believe that the candidate company, if successful, could achieve some level of gross revenue at the end of the fifth year in business. Today, for me, that hurdle number is $20 million.” In other words, only use Berkus if you anticipate extraordinary growth.
5. Risk Factor Summation Valuation Method (Similar to Scorecard Valuation)
The Risk Factor Summation (RFS) method starts with the average valuation of similar online businesses as a baseline, and then you adjust that up or down depending on risk factors such as manufacturing, technology, legislation, reputation, and more.
Essentially, you compare your business with others like yours to get a rough starting point. If the average value of online businesses like yours is $1 million, for example, that’s the base line and then you adjust up or down depending on the specifics of your business. Your valuation might be better, worse, or the same depending on the businesses being compared.
For each risk factor you measure, you award a score of between -2 and 2, with 2 being the best. Positive scores adjust your baseline up by $250,000 (1) or $500,000 (2). Negative scores reduce by the same amounts. At the end, you arrive at a final valuation adjusted for each risk.
Similar to the Berkus methodology, you can choose alternative values (different monetary amounts) for each score to fit your location and market sentiment. Obtaining the baseline might be tricky since you’ll have to research the market and industry reports to get the numbers. Or speak to their founders.
When Should You Use the Risk Factor Summation Valuation Method?
You’ve probably also noticed that this is a qualitative valuation methodology, so choose the risk factor summation valuation method if your business is pre-revenue or lacks financial data. Angel investors, for example, often use RFS to decide which startups to add to their portfolio.
6. Precedent Transaction Analysis Valuation Method
To value an online business with precedent transaction analysis, you need access to past mergers and acquisitions (M&A) transaction data. As a result, this can be a more difficult valuation method for business owners since this data might not be publicly available.
Does that mean you can’t use it to value your business? No, but you’ll have to play detective to hunt down the necessary information. While the bigger transactions tend to make the headlines, NDAs can lock down the details. You might find company press releases fill in the gaps.
Today’s founder communities are also welcoming and collaborative. Many founders might be happy to share the data of past companies they sold if it helps you sell yours. All you can do is ask. For a more accurate business valuation, you’ll need to know some or all of the following:
- Transaction size
- Valuation method (and multiple if possible)
- Product or service offering
This list isn’t exhaustive. The more data you can gather, the better your valuation will be. Assuming you’ve compiled a database of similar companies to yours, calculate an average multiple and plot it against some of the other valuation methods on this list.
The final valuation will rest on the data. Is your precedent transaction valuation far adrift of the other valuation methods in this list? If so, why? A rationale might justify the valuation to a financial buyer, but expect them to use their own financial models too.
When Should You Use the Precedent Transaction Analysis Valuation Method?
The precedent transation analysis valuation method is usually reserved for M&A professionals with insight into closed deals such as private equity groups. You can use it for virtually any business conditional on you obtaining the data for similar businesses. The bigger your dataset, the more accurate the valuation, and the more likely a financial buyer will accept it.
7. Use a Free Business Valuation Calculator (SaaS)
As well as the valuation methods above, you can also value your online business using a free calculator. We offer a free SaaS business calculator called MicroMRR, a SaaS valuation and analytics platform that combines data from 100s of closed acquisitions.
MicroMRR syncs with your Stripe account and anonymized acquisition data on Acquire.com. You then receive meaningful, actionable insights into your startup’s valuation and performance. Currently, MicroMRR collects data across six critical metrics:
- New Monthly Recurring Revenue
- Annual Recurring Revenue
- Monthly Recurring Revenue
- Churned Monthly Recurring Revenue
By comparing your financials with those of closed acquisitions on Acquire.com, you can calculate a valuation that reflects your performance and market sentiment. The more acquisitions close on Acquire.com, the more accurate MicroMRR becomes.
You can also visualize your data in simple, clear charts which makes it easier to spot trends and project performance. You might even share your MicroMRR account with buyers or advisors.
How to Justify Your Valuation to Buyers
Valuations are a sore point in many acquisition discussions because you and the buyer have different priorities. But when you value your business based on data, you minimize the cause for disagreement. You might also identify growth strategies that help you get acquired at a better valuation in the future.
It’s hard to stay objective when valuing your business. It’s like writing an appraisal for an employee who’s also a close relative: You need to take a cold, critical eye but also don’t want to hurt their feelings, or in the case of a valuation, your ego. Better to let the numbers speak for themselves rather than allow emotion to invalidate your valuation.
Once you ground your valuation in data, you know where to open negotiations with buyers. Many startups fail to attract offers because of an inflated asking price. But when you can back up your valuation with numbers and market insight, you not only negotiate from firmer ground, but also demonstrate to buyers that you’ve prepared for acquisition and are ready to play fair.
Which Valuation Method Gives the Highest Valuation?
The valuation method most likely to give the highest valuation is precedent transaction analysis. Why? Well, it’s common for a buyer to pay a little above the market value of a company’s share price just to get a controlling stake – called a “control premium”. Since precedent transaction analysis uses past acquisition transactions to determine the value of a business today, it’s likely that that valuation will include this control premium, which would result in a higher valuation than what’s perhaps correct in the market.
What Is the Easiest Way to Value an Online Business?
The easiest way to value an online business is to hire a valuation professional to do the calculation for you. They have a grasp on the market and know which of the various valuation methods is the most appropriate for your business. A valuation expert can also take an objective approach to your valuation, which is a struggle for most founders who’ve grown attached to their businesses.
If you’re rather not pay for a professional valuation, or just want an estimate, a valuation calculator like MicroMRR is the next simplest method, followed by the multiple valuation method. The latter can be as quick as taking an average multiple of closed acquisitions in your niche using our multiples report and applying it to your revenue or profit.
What Is the Fastest Way to Value an Online Business?
The fastest way to value an online business is to use a valuation calculator. If you own a SaaS business, you can obtain a free valuation online by connecting your Stripe metrics to MicroMRR.
Other calculators exist online for other industries, but if you’d rather do the calculation yourself, consider the multiple valuation method, sometimes referred to as a “rule of thumb” valuation. Apply a justifiable multiple to your revenue, EBITDA, or SDE and that gives you a quick idea.
Deciding on the multiple is the tricky part. You can’t pluck it out of thin air but must instead research average multiples for your industry and then adjust up or down according to the specifics of your business.
How to Value a Business With No Assets
To value a business without assets, first ask what that means – are there really no assets or is it that the assets are not tangible (like property) but intangible (like a patent)? Tangible, physical assets are usually much easier to value, but intangible assets involve some speculation.
First, ask what type of buyer might be interested in the intangibles of the business. If you own the patent for a revolutionary new smartphone, perhaps Apple or Google would pay a fortune to buy your business if it meant acquiring that patent. Same goes for other intellectual property.
Valuing intangible assets is an inexact science, but if you can demonstrate their potential for generating revenue, you can use pre-revenue valuation methods such as cost-to-duplicate, Berkus, risk factor summation, or precedent transaction analysis to value your business.
Why Are SaaS Valuations So High?
SaaS valuations are higher than many other industries because they run on a fairly standard business model that pays recurring revenue. Predictable revenue is attractive to buyers since it helps them de-risk the acquisition of a company.
SaaS businesses also tend to enjoy higher lifetime customer values given recurring payments and annual subscriptions, and their overheads are a lot smaller – most just need web hosting and a domain. As a result, investors have flocked to SaaS companies believing them to be high-growth, low-to-medium-risk ventures – and demand for them has pushed valuations higher than other industries.
The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before entering into any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.