Business valuation explained in simple terms: What is my company worth?

The four most important evaluation methods and how to truly understand your evaluation

This is the fundamental question for every entrepreneur who wants to sell their company or needs to determine its value – whether for a planned transaction, discussions with banks, or for family matters: "How much is my company worth?" Unfortunately, there's no simple answer. There are several answers, depending on the method you use. In this article, we'll explain the four most important valuation methods so you can understand what your company is truly worth.

The core concept: Enterprise Value vs. Equity Value

Before we delve into the methods, we need to distinguish between two terms: Enterprise Value (also "gross value" or "company value") and Equity Value ("net value" or "equity value").

Enterprise Value (EV): The gross value

Enterprise value is the theoretical value of a company as if it were debt-free. It's the "business itself"—without considering debt or money in the bank. It's the value an investor would pay for the operating assets if they were financing the business themselves.

Equity Value (EqV): The net value

Equity value is what the shareholder ultimately receives. It's the enterprise value minus debt plus cash. In other words, it's the value that belongs to the equity.

The Equity Bridge: The connecting link

The relationship is simple:

Equity Value = Enterprise Value – Net Debt (± Working Capital Adjustment)

For example: A company has an enterprise value of €10 million. It has €3 million in debt (bank loans) and €500,000 in cash in the bank. The net debt is €3 - 0.5 = €2.5 million. The equity value is €10 - 2.5 = €7.5 million. This is what the shareholder receives net.

Enterprise value is the business. Equity value is the money that goes into your pocket.

Evaluation method 1:

Net Asset Value

The first method is the oldest and least used in modern M&A: the intrinsic value. This is the "What does it cost to build this company from scratch?" question.

How does it work?

They take all the company's assets (machinery, buildings, inventory, receivables), value them at today's market price, and add them up. Then they subtract all liabilities. That's the net asset value. There are two variations:

Gross asset value: The sum of all assets at market prices (without deducting liabilities).

Net asset value: The gross asset value minus liabilities. This is what the shareholder receives net.

When is this used?

Asset value is a lower limit. No rational business should be sold below its asset value. If your company has a net asset value of €5 million, you shouldn't sell it for €3 million. But asset value is rarely the right valuation for an operating, profitable business. Why? Because it ignores profitability. A highly profitable company with old, cheap machinery might have a low asset value but a high earnings value. Asset value is mainly used for companies that have little or no operating activity (e.g., property management companies). For operating mid-sized companies, it serves only as a lower limit, not as a primary valuation method.

Evaluation method 2:

Multiplier method (multiples)

This is the most commonly used method in practice. It's simple and quick, which is why it's popular. The procedure is: Take a financial multiplier for the company and multiply it by a market multiplier.

The concept

Company performance = Key figure × Multiplier

A simple example: Your company has an EBITDA (Earnings Before Interest, Tax, Depreciation, Amortization) of €2 million. The market multiple for companies in your industry is 8x EBITDA. Then your company value is €2 million × 8 = €16 million.

Which key performance indicators (KPIs) are used?

The most common ones are:

EBITDA: Earnings Before Interest, Tax, Depreciation, Amortization. This is operating profit excluding financing effects and depreciation. It is the most popular key performance indicator for M&A.

EBIT: Earnings Before Interest and Tax. This is the profit before financing and taxes, but after depreciation. Less commonly used, but important for capital-intensive companies.

Revenue: Simply total revenue. Used for companies with very different profitability. Example: Banks are often valued based on revenue.

Annual net income (PAT): Net profit after taxes. This is the lowest figure in the P&L and is used less frequently because it fluctuates.

Where do the multipliers come from?

The multipliers come from two sources:

Market multiples: These are the multiples of publicly traded companies in your industry. If you own a mechanical engineering company, look at the EBITDA multiple at which publicly traded mechanical engineering companies are valued on the stock market. This is current market data.

Transaction multiples: These are multiples derived from comparable past M&A transactions. A typical example would be: "In 2023, a comparable-sized mechanical engineering company was sold for a multiple of 7x EBITDA." In practice, such transaction multiples are often more meaningful than comparable listed companies because they reflect actual purchase prices. However, access to this data is limited. While relevant information is regularly published in trade journals, databases, and M&A reports, it is frequently only available in aggregated form or for a fee.

Trailing vs. Forward Multiples

A key difference: Trailing multiple (backward multiple) is based on past earnings. Forward multiple (forward multiple) is based on future expected earnings. For example, if your EBITDA was 2 million in 2023 (trailing) and you expect 2.2 million in 2024 (forward), the valuation may differ depending on whether you use the 2023 or 2024 multiple.

Typical EBITDA multiples by industry and size

These are indicative figures; they vary depending on the economic situation and industry:

Small businesses (EBITDA up to €1 million): 4-6x EBITDA

Medium-sized companies (EBITDA €1-10 million): 6-10x EBITDA

Large companies (EBITDA over €10 million): 8-12x EBITDA

Tech/SaaS companies: 10-20x EBITDA (or even higher if growth rates are high)

Crafts/Services: 4-7x EBITDA

EBITDA multiples are the backbone of modern M&A valuation. They are simple, but often underestimate the complexity of the business.

Assessment method 3:

Income approach (IDW S1)

The income approach is a method that looks at future profits and discounts them to present value. It is theoretically more rigorous than multipliers, but practically more complex and susceptible to manipulation.

The concept

The idea is simple: A company is worth as much as the present value of its future profits. If you expect the company to make €1 million in profit per year for the next 5 years, then discount these profits to today's value and add them together.

IDW S1: The standard in Germany

In Germany, the standard for the earnings-based valuation method is "IDW S1" – a standard issued by the Institute of Public Auditors in Germany (IDW). IDW S1 states: Take the "normalized" profits (i.e., the average, adjusted profits), project them 5-10 years into the future, and discount them using a "capitalization rate" (a discount rate that takes risk into account).

Capitalization rate (discount rate)

The capitalization rate is key. It's a rate that reflects the company's risk. The riskier the company, the higher the rate, and therefore the lower the valuation. For German SMEs, the capitalization rate typically ranges between 8% and 15%, depending on the risk.

The problem with income value

The income approach to valuation is susceptible to manipulation. Why? Because you have to project profits. And the seller has a strong incentive to project profits upwards. "Well, the next five years will be fantastic, we've landed a major client..." Suddenly, the valuation is 30% higher. This is a problem that manifests itself in practice.

Assessment method 4:

DCF method (Discounted Cash Flow)

The DCF method is theoretically the cleanest and most preferred by Warren Buffett and other investors. But it is also the most complex.

The concept

The idea is this: A company is worth as much as the free cash flows it can generate in the future, discounted to today's value. That's "cash"—not profits, not revenues, but cash.

Free Cash Flow (FCF)

Free cash flow is the cash generated by the company after operating expenses and reinvestments have been paid. It is the money that is "free"—that you can take out of the business.

WACC: Weighted Average Cost of Capital

The WACC is the discount rate. It is a weighted average of the cost of equity and debt. It is complex to calculate, but it reflects the "risk" of the company. The higher the WACC, the higher the risk, and therefore the lower the valuation.

Terminal Value

A key component of the DCF method is the "terminal value"—the company's value at the end of the projection period (e.g., year 10). This often represents 50–70% of the total valuation, making the terminal value assumption critical. A small error in the terminal value assumption can alter the entire valuation by 20%.

Why does Buffett love the DCF method?

Buffett uses the DCF method because it answers the question that matters to him: "How much cash can I take from this company in the long term?" It's pragmatic and focused on what's important. But the method is prone to errors in its assumptions, especially regarding terminal value.

Normalizing profits: The critical detail

Regardless of the method you use, there's one critical detail: profit normalization. This means you need to "clean up" the historical profits to see how much the business typically makes.

What needs to be normalized?

Owner's salary: If the seller is charging a very high salary that is not in line with market rates, this needs to be adjusted. A buyer would pay a more appropriate managing director.

One-off items: Sale of real estate, restructuring costs, insurance payouts. These should be excluded from profits.

Related-party transactions: If the seller "rents" to themselves (e.g., a building that the seller owns privately and rents to the company), the rent must be normalized to market rates.

Extraordinary losses: product rejection, legal disputes, theft. These should be excluded from the calculation if they are not systemic.

Practical considerations: The gaps and deductions

Theory says: Calculate the enterprise value using one method. But in practice, it's full of adjustments and discounts.

Size discount (fungibility discount)

One problem with smaller companies is that they are less "fungible"—less easily replaceable in the market. A buyer knows it's difficult to find another similar buyer. Therefore, there's often a discount for size. A very small company might command a 20-30% discount simply because it's riskier.

Key person dependency

If the company is heavily dependent on one person (e.g., the founder with a customer relationship), then there will be a discount. A buyer will pay less if they face the risk of the key person leaving. A 20-30% discount is not uncommon.

Synergies

On the other hand, a buyer might pay a premium if they see synergies. For example, a buyer with a large sales network could make the company more profitable than it is today. The buyer might pay an extra 15-25% because they see where the synergies lie.

What something is worth and what someone is willing to pay are two different things. The true purchase price lies somewhere in between.

A practical example:

The metal processing company

Let's look at a real-world example. A metalworking company, founded 20 years ago, has the following financial situation:

Revenue: 10 million euros

EBITDA: 2 million euros (20% EBITDA margin)

Debts: 1 million euros

Cash: 200,000 euros

Net worth (asset value): 2.5 million euros

Evaluation using different methods:

Multiplier method: 2 million EBITDA × 7x = 14 million Enterprise Value

Equity Value: 14 - (1 - 0.2) = 14 - 0.8 = 13.2 million euros

Earnings value method: Normalized profits of €1.4 million/year, capitalization rate 10%, approx. €12-14 million enterprise value

DCF method: FCF €1.6 million/year, WACC 9%, Terminal Growth 3%, approx. €15-18 million Enterprise Value

Summary: The valuation ranges between €12-18 million for the enterprise value, depending on the methodology and assumptions. The equity value (what the seller receives) would be approximately €11-17 million after deducting debt. This is a wide range, but it demonstrates that different methods can yield different results.

A smart seller would obtain several valuations (from an investment banker or an independent appraiser) and determine the consensus valuation. Then they can negotiate with potential buyers.

The critical point: What is the difference between "value" and "selling price"?

This is the most important insight: What the company is "worth" and what someone is "willing to pay" are two different things. The purchase price is somewhere in between, depending on negotiation, market conditions, and synergies.

The valuation is the foundation. But the selling price is determined by supply and demand. If many buyers are interested, the price rises. If few are interested, the price falls. A sound valuation protects you from undervaluation, but it doesn't guarantee the best price.

Practical tips: How to understand your rating

1. Obtain multiple opinions: A tax advisor/auditor, an investment banker, perhaps an academic reviewer. See where the consensus lies.

2. Understand the assumptions: Every valuation is based on assumptions (EBITDA multiple, growth rate, discount rate). Ask about these assumptions and check whether they make sense.

3. Normalization is critical: If the appraiser does not normalize your profits, you will see surprising differences compared to buyer valuations.

4. EBITDA is the lingua franca: In practice, buyers talk about EBITDA multiples. Understand the EBITDA multiple at which companies in your industry are sold.

5. Don't set your price anchor too early: Your valuation is important, but don't reveal your price expectation too soon in the negotiation process. Let the buyer form their own opinion.

6. Synergies are gold: When buyers see synergies, they pay more. Make it clear where the synergies lie (sales, technology, production).

Conclusion: The correct assessment is the foundation

Business valuation isn't exact – it's more of an art than a science. But a good valuation gives you a foundation for negotiations and protects you from being undervalued. The key points:

1. Understanding Enterprise Value and Equity Value

2. Know the four methods and understand their strengths/weaknesses

3. Normalize profits – this is critical for realistic valuations.

4. Obtain multiple assessments and understand the assumptions.

5. Know that the valuation is the foundation, but the purchase price depends on negotiation.

If you're planning to sell your business, invest in a thorough valuation. It's not expensive compared to what you're selling. A good valuation can get you 10-20% more for the sale price. That's the best ROI investment you can make.