There is no question that small and independent businesses are making a comeback. In the New Yorker article Small Is Bountiful, Tim Wu shows how an increasing number of consumers are flocking to buy from small businesses after decades of buying from big corporations. These small businesses that are winning the hearts of consumers do not have the economies of scale big businesses do, but these small business owners are finding creative ways to differentiate their products and services and not compete on price.

The idea of owning and operating a small business is gaining popularity not just from individuals, but also from venture capitalists that do not typically buy small businesses. In this New York Times article, Alina Tugend portrays three venture capitalists who decide after researching 1,000 businesses to put their money not in a Silicon Valley startup, but a snow removal and landscaping business in Maine. While this move might seem unusual for venture capitalists, it makes total sense for these three VCs. According to the Small Business Administration, about half of all startups fail within 5 years. In other words, buying an existing business is a lot less risky than starting one from scratch.

When it comes to being your own boss, most people think of starting a business from scratch. However, more and more entrepreneurs are beginning to see why buying a business may be a lot smarter and less risky than starting one from the ground up. According to the SBA publication above, a firm’s probability of survival increases with its age. By buying an established business, one effectively skips over the initial curve of death.

Knowing how to value a small business is crucial to one’s success in buying a business. Most MBA programs and business schools only teach people how to value large corporations. Unfortunately, the process of valuing large, publically traded companies have little consequence to valuing a small, privately held operation. In the mergers and acquisitions of mid-sized and large companies, the buyer is often making a strategic move. The purchase may be motivated by the desire to buy out a competitor, acquire a proprietary technology, or gain access to the target company’s audience. In contrast, small business buyers are usually individuals looking for steady cash flow. They rarely buy companies with management in place. The seller is looking to move on and the buyer takes over the seller’s role as the management. Rather than performing a net present value analysis by discounting projected cash flows in the future, the buyers of small businesses tend to base their business valuation on historical financials. After all, these are individuals looking for companies with proven cash flow so they know they can pay the bills once they become the new management.

When the buyers of a small business are evaluating the company, the business valuation process usually starts by understanding the background of the business along with obtaining the last three years of tax returns along with a year-to-date income statement and balance sheet. Special emphasis is placed on the most recent 12 months of financial performance since the business valuation is heavily based on the company’s recent financial performance. A business valuation professional would obtain the necessary information from the owners of the company in order to recast the financial statements. The seller’s discretionary cash flow or EBITDA are calculated, and the correct multiple applied based on the industry, competitive position of the subject company, the business history, and other factors. The more desirable the business is in the eyes of potential buyers, the higher the multiple one can fetch. In the world of buying and selling a small business, a desirable business usually means one that has a strong cash flow and some special competitive advantage such as being in a niche industry with limited competition.

In summary, owning a small business is gaining popularity and buying a business is perhaps one of the least risky ways of becoming a small business owner. Whether the objective is to buy or sell a business, obtaining an accurate business valuation will maximize one’s chances for success.

Advantage Business Valuations provides business valuation services for small to mid-sized business owners in the United States. Founded by Aaron Muller who has valued thousands of companies as a business broker, Advantage Business Valuations helps small to mid-sized business owners determine the value of their business with ease and confidence. To discover the value of your business, visit www.AdvantageBusinessValuations.com.