My favorite form of valuation is to understand value based on minimum income. I always believe this is the fastest and most accurate method to understand the value someone is willing to pay for a company.

The average household income in America is around $55,000. So this will be our base number. Remember that a business owner will need to have around 55k to live on. It’s a minimum income. And this income is not available for debt service.

(debt service is the term used to describe your monthly payment to pay an installment loan)

So if a company makes $100,000 per year for the owner, then he only has around $45,000 to pay for debt service. This includes debt, plus interest, plus any capital reinvestments into the company.

Capital reinvestment

Every year a company will need to reinvest an amount of capital back into the business. This is a variable number but you should plan on it being at least 10% of the net income. So from the 100k that our ficticious company makes, and the 55k the owner takes to live on, you have to also account for 10k to go towards capital reinvestment.

This means you now only have $35,000 to pay any debt and interest on the business.

Debt pay back period

The bible says that every 7 years is the year of canceling debts. Similarly, bankruptcy laws in america allow you to claim bankruptcy every 8 years (its actually based on the biblie 7 years).

Also, statistically, the economy goes in 7 year cycles.

Theres something about every 7 years things go up and down.

Oddly enough investors will want no more than a 3 to 5 year repayment amount and a 5 to 10 year repayment period. This means they will allow up to 3 to 5 years of disposable income (not discretionary earnings) and ask to have a 5 to 10 year repayment term so they have wiggle room just in case it doesn’t work perfectly.

Applied to Company value

So that company that makes 35k in disposable income?

It’s likely worth 3x to 5x. So somewhere inbewteen $105,000 to $175,000.

Does this valuation method work for larger companies? Yep.

If you made 500k in SDE, meaning you are an operator and dont have a management tema in place, you might have a normal valuation of 4x sde, or $2,000,000.

Using the Mnimum Income valuation method, you have 445k in disposable income, with a 3 to 5 year repayment term, you have a rough valuation of 1.4m to 2.22m, so again near 2 million dollars.

And using an EBITDA multiple, you would make around 400,000, with paying 100,000 towards a manager, and the company would have perhaps a 5x multiple (about 1 point higher than SDE methods). Again leaving us with a rough valuation of 2 million.