Andrew Markou is the CEO and Co-Founder of BusinessesForSale.com. He has extensive experience in the business for sale market and the factors that influence valuation. He is also the author of A Pocket Guide to Buying a Business, which explains the acquisition process and explores how buyers can assess what a business is worth.
What is a business really worth?
Ask the owner and you may get one answer. Ask a prospective buyer and you could get another entirely. Neither perspective necessarily tells you the price at which the business will ultimately change hands.
After more than 30 years of helping owners bring businesses to market in Canada and around the world, we know that business valuation is both an art and a science. The numbers matter, but they only take you so far. Ultimately, a company is worth what a credible buyer is prepared to pay – and reaching that number will usually involve negotiation as well as accounting.
In this guide, we’ll look at how to value a business in Canada using the most common valuation methods and formulas. We’ll also explain what information you need, how buyers and sellers can interpret value differently, the mistakes that can undermine a valuation and when it may be worth bringing in a professional.
Tip: To get started quickly with business valuation, try BusinessesForSale.com's free ValueRight business valuation calculator.
How Do You Value a Business?
There are several ways to calculate the value of a business. Depending on the company, a valuation might be based on its earnings, assets, revenue, future cash flows or evidence from comparable business sales.
For many profitable small and medium-sized businesses, the basic principle can be expressed as:
Indicative business value = Maintainable earnings × Appropriate valuation multiple
The important word here is maintainable. A buyer is interested not simply in what the company earned last year, but in the level of earnings it can reasonably be expected to produce under new ownership.
Choosing the right multiple is more complicated. It may be influenced by the company’s risk profile and performance, evidence from businesses operating in the same industry and prices achieved in comparable transactions. Market conditions and negotiations between parties can also affect the eventual figure.
This formula is only a starting point. A manufacturing company with substantial machinery and a rapidly expanding software business have very different characteristics, and the most appropriate valuation method may differ accordingly.
What Do You Need to Value a Business?
A valuation is only as reliable as the information used to produce it. Before attempting to establish a value, buyers and sellers should assemble a clear picture of the company’s financial performance, assets, obligations and commercial position.
|
Information |
Why it matters |
|
Financial statements covering at least three years |
Show revenue, expenses, profitability and longer-term performance |
|
Recent interim or management accounts |
Give a more current picture than the latest year-end statements |
|
Relevant corporate records and filings |
Can help confirm important information about the corporation and its ownership |
|
Balance sheets |
Show assets, liabilities, cash and debt |
|
Cash flow statements |
Reveal how effectively accounting earnings translate into cash |
|
Owner compensation and benefits |
Help establish the financial benefit received by a working owner |
|
Discretionary and non-recurring expenses |
Identify potential adjustments to reported earnings |
|
Asset register |
Lists property, machinery, vehicles and other significant assets |
|
Outstanding debts and liabilities |
Helps establish what the business owes and how a transaction may need to be structured |
|
Revenue by customer |
Highlights potentially risky dependence on major customers |
|
Contracts and recurring revenue |
Help establish the predictability and transferability of future income |
|
Forecasts and sales pipeline |
Provide evidence of future opportunities, although projections require careful scrutiny |
|
Leases, licences and intellectual property |
Identify important contractual rights, commitments and intangible assets |
Prospective buyers are likely to scrutinize these records during due diligence. Missing financial information, unexplained costs or overly ambitious forecasts can come back to bite you, so do your homework.
What Are the Main Business Valuation Methods?
Most approaches to business valuation can be grouped into three broad families.
Earnings-based valuations concentrate on the profit or financial benefit produced by the company. Asset-based methods look at what the business owns and what it owes. Market- and future-based approaches use information such as comparable transactions, revenue or projected future cash flows.
No method provides the perfect answer for every company. Understanding the differences between them – and the types of businesses they suit – is therefore an important part of establishing a realistic valuation.
Seller’s Discretionary Earnings
Seller’s Discretionary Earnings, usually shortened to SDE, is a common method for valuing smaller owner-operated businesses.
Rather than relying solely on the profit reported in the financial statements, SDE attempts to calculate the total financial benefit available to a single full-time owner-operator. It does this by adjusting earnings for certain expenses and benefits associated with the current owner.
These adjustments might include owner compensation and benefits, interest, depreciation and amortization, legitimate discretionary expenditure and genuine one-time expenses.
When Is SDE Most Useful?
SDE tends to work best for businesses in which the owner is actively involved in day-to-day operations and takes compensation or other benefits from the company.
A local service company, independent store, restaurant, trades business or small agency might fall into this category. It is particularly useful when a purchaser expects to take over the seller’s working role after the acquisition.
How Do You Calculate SDE?
A simplified formula is:
SDE = Pre-tax earnings + owner’s compensation and benefits + interest + depreciation and amortization + eligible discretionary expenses + non-recurring expenses
After calculating a maintainable SDE figure, you can apply an appropriate valuation multiple:
Indicative business value = Maintainable SDE × SDE multiple
Consider a Canadian marketing agency generating C$100,000 in annual pre-tax earnings. The working owner receives C$50,000 in compensation, and the financial statements include another C$10,000 of legitimate personal or one-time costs that would not continue under new ownership.
Its SDE would be:
C$100,000 + C$50,000 + C$10,000 = C$160,000
Suppose relevant market evidence indicated that a multiple of three was appropriate. The calculation would then be:
C$160,000 × 3 = C$480,000
C$480,000 is an indicative value, not a guaranteed selling price. Whether that multiple is justified will depend on the quality of the business itself, including its growth, customer concentration, competitive position, dependence on the owner and other risks a buyer would inherit.
EBITDA Multiple Valuation
For larger and more established businesses, EBITDA may provide a more appropriate measure of underlying profitability.
EBITDA means earnings before interest, taxes, depreciation and amortization. By stripping out financing costs, taxes and certain non-cash accounting charges, it can make comparisons between companies with different capital and accounting structures easier.
Which Businesses Are Better Suited to EBITDA?
EBITDA multiples are more commonly associated with established companies that have their own management structure and can operate without depending entirely on one working owner.
That distinction is important. SDE generally assumes that one owner-operator’s compensation can be included when calculating the total benefit available to a purchaser. EBITDA does not make the same assumption.
How Is EBITDA Calculated?
In simplified form:
EBITDA = Net income + interest + taxes + depreciation + amortization
An appropriate EBITDA multiple can then be applied:
Enterprise value = Maintainable EBITDA × Appropriate EBITDA multiple
While EBITDA is useful, it isn’t the same thing as cash flow. For example, it does not account for capital expenditures or movements in working capital. A company can therefore report healthy EBITDA while generating substantially less cash than the headline figure might suggest.
Asset-Based Business Valuation
Instead of focusing on earnings, an asset-based valuation considers the underlying value of what the company owns after accounting for what it owes. The simplest formula is:
Net asset value = Total assets − Total liabilities
Assets can include real estate, machinery, vehicles, inventory, cash and accounts receivable. Liabilities may include loans, unpaid bills, taxes payable and other outstanding obligations.
When Does an Asset-Based Valuation Make Sense?
This method is most useful when tangible assets account for a significant proportion of a company’s value. Manufacturers, agricultural businesses, property businesses and companies with valuable machinery or substantial inventory are potential examples.
The approach is less revealing when the real value of the company comes from things that are difficult to capture on a balance sheet – its brand, employees, customer relationships, intellectual property or ability to generate future earnings.
Book Value and Fair Market Value
One of the challenges of an asset-based valuation is that the number appearing in the financial statements may bear little resemblance to an asset’s current market value.
Machinery purchased several years ago could now sell for a fraction of its original cost. Real estate acquired a long time ago might have increased significantly in value. Some inventory could be obsolete, while certain accounts receivable may never be collected in full. For that reason, an asset valuation should always distinguish between book value and fair market value.
What Is Liquidation Value?
Liquidation value takes a more conservative approach. It estimates the amount that could be recovered if assets had to be sold and the company’s liabilities settled.
The money made in a forced or accelerated sale may be significantly lower than the value achievable through an orderly sale. Liquidation value can therefore be more useful when assessing a distressed or underperforming business than when valuing a healthy company that will continue operating after the transaction.
Discounted Cash Flow Valuation
Discounted cash flow, or DCF, takes a different approach by looking forward rather than relying primarily on historical earnings. The method estimates the cash a company is expected to generate in future years and then converts those future cash flows into a present value.
The underlying principle is the time value of money. C$10 received today is worth more than C$10 received several years from now because money available today can be invested and because future payments involve uncertainty.
A simplified DCF formula is:
DCF value = [CF₁ ÷ (1 + r)¹] + [CF₂ ÷ (1 + r)²] + … + [CFₙ ÷ (1 + r)ⁿ] + discounted terminal value
In this calculation:
- CF is the forecast cash flow for each period
- r is the discount rate
- n represents the relevant period
The terminal value estimates the value associated with cash flows beyond the explicit forecast period.
Which Businesses Are Suitable for DCF?
DCF is most useful when a company has sufficiently predictable cash flows and credible long-term forecasts. It can be particularly relevant to larger businesses and investments where expected future performance tells you more about value than a single year’s historical earnings.
Which Valuation Method Is Right for Your Business?
There is no universally superior valuation method. The characteristics of the company should guide the choice.
|
Type of business |
Potential starting method |
|
Small owner-operated business |
SDE multiple |
|
Established company with independent management |
EBITDA multiple |
|
Asset-heavy business |
Adjusted net asset valuation |
|
Distressed or loss-making company |
Asset-based or liquidation valuation |
|
Stable company with predictable future cash flows |
Discounted cash flow valuation |
It can also be useful to approach the same company from more than one direction. Professional valuators, accountants and business brokers may use several methods and sources of evidence before arriving at their conclusion.
What Is a Business Valuation Multiple?
A valuation multiple is a benchmark applied to a particular financial measure – usually something such as SDE or EBITDA – to estimate business value.
Suppose several genuinely comparable businesses have changed hands at between 2.5 and 3.5 times SDE. That information may help establish an initial range for another company with similar characteristics.
The difficulty lies in the word comparable.
Two businesses can operate in exactly the same industry and still differ significantly in scale, margins, location, growth rate, customer concentration, recurring revenue and reliance on the owner. Those differences can justify very different multiples.
Private company transaction data can also be difficult to obtain. For that reason, professional advisers may draw on transaction databases, industry research and their own experience of completed sales when assessing an appropriate multiple.
The Canadian market adds another consideration: geography. Conditions can vary considerably between provinces and between major metropolitan areas and smaller communities. The availability and cost of labour, commercial real estate, access to customers, regional economic conditions and the size of the potential buyer pool can all influence demand for a particular business.
A valuation multiple should therefore never be treated as an automatic answer. It is a piece of market evidence that needs to be considered alongside the specific strengths and weaknesses of the company being valued.
Five Business Valuation Mistakes to Avoid
After decades of supporting business buyers and sellers, we’ve seen how seemingly small valuation errors can lead to very different conclusions. These are five particularly important ones to watch for.
Using the Wrong Earnings Figure
SDE, EBITDA, net income, revenue and cash flow measure different things. They should not be treated as interchangeable. Combining a multiple with the wrong earnings measure can produce a seriously misleading result.
Adding Back Too Many Expenses
Adjustments are an important part of normalizing a company’s earnings, particularly in an owner-operated business. However, every adjustment needs to be defensible – and recorded. A genuine one-time expense or personal cost might reasonably be removed, but a recurring expense cannot simply disappear to produce a more attractive valuation.
Focusing on a Single Year
A particularly strong 12 months may make a business look more valuable, but buyers will want to know whether that performance can continue. Reviewing several years of results makes it easier to identify trends and unusual periods. If earnings are rising or falling sharply, understanding why may matter just as much as calculating the historical average.
Counting the Same Assets Twice
If an earnings-based valuation assumes that the company’s normal operating assets are needed to produce those earnings, their economic contribution may already be reflected in the valuation. Adding the full value of equipment, inventory or other operating assets afterwards can result in double-counting.
Assuming the Valuation Is the Sale Price
A valuation gives you an informed estimate of value, but it does not tell you exactly what a buyer will ultimately pay. Due diligence may uncover information that causes a purchaser to revise an offer, or the structure of a transaction can change its economics. The asking price, valuation and final transaction price are related, but they are not necessarily the same number.
Can You Value a Business Yourself?
It is possible to produce an initial valuation yourself, particularly if you have reliable financial information to hand. BusinessesForSale.com’s ValueRight business valuation calculator can be a great place to start – it’s free and easy to get started.
If a valuation will be used for taxation, shareholder matters, litigation, succession planning or another formal purpose, specialist advice may be appropriate. Canadian business owners can seek assistance from professionals such as CPAs and Chartered Business Valuators, as well as experienced business brokers where the purpose is to understand potential market value ahead of a sale.
Finding the Right Value
There is no formula capable of capturing every reason one business may be worth more than another.
The financial statements are fundamental, but buyers will also consider the quality and sustainability of the earnings behind them. A company with loyal customers, recurring revenue, documented systems, growth opportunities and a management team capable of operating without the owner is likely to be viewed differently from one with similar earnings but much greater risk.
That is why the strongest valuations tend to combine several things: reliable financial information, an appropriate valuation method, relevant market evidence and a realistic assessment of the business itself.
Ultimately, business valuation is not about finding one mathematically perfect number. It is about building enough evidence to arrive at a credible range – and understanding the factors that could move the final price within it.
Frequently Asked Questions About Business Valuation in Canada
How Much Does a Business Valuation Cost in Canada?
The cost varies depending on the size and complexity of the business and the purpose of the valuation. For an initial estimate, BusinessesForSale.com’s free ValueRight business valuation calculator can be a useful starting point.
Do I Need a Chartered Business Valuator to Value a Business in Canada?
Not necessarily. You can produce an indicative valuation yourself, but a Chartered Business Valuator (CBV) may be appropriate when an independent or formal valuation is required.
Does Location Affect the Value of a Business in Canada?
Yes. Labour costs, commercial real estate, local demand, competition and the size of the buyer pool can vary significantly between Canadian provinces and communities, potentially affecting what buyers are prepared to pay.