The most important thing to remember is that above all else, the valuation of a business is subjective. As with anything, the true value of something is established by what another party will pay for it. In private businesses, this is difficult to determine because shares of them are not sold on any open market (i.e. a stock exchange). Even when you do engage a firm for an independent valuation, their value is based on what they have been told, on their review of the financial reporting, and/or possibly even on a forward-looking financial forecast that depicts the future potential.
The real question is, what are some fundamental items that can either increase or decrease value in a small business?
- Quality of Financial Reporting: for any business, your financial reporting does more than just show what you earned and spent in any given period. Your financials have to tell the story of how your business has been operated, how it has grown, and how it has either succeeded or failed over time (particularly in the most recent 12-to-36-month period). If you can use your financial reporting to demonstrate how your intentional decisions have resulted in improved performance, the value of your business will benefit from that. If your financials are not sophisticated enough to do that, the value of your business will be harmed by the fact that they are lacking in that area.
- Management Team: when an Owner (and sometimes their immediate family members) play too much a part of the key value driving roles of a business (for example: sales, skilled service delivery, etc.) the value of that business is diminished. This is because if someone was to purchase the business, and the Owner was no longer involved, the value they are personally bringing will no longer be present. This is similarly true if the Owner was unable to participate in the business for any other reason. In very small businesses, this level of Owner involvement is often inevitable, but as the business grows, it should be a priority to evolve away from it as much as possible. This process could take many years to accomplish.
- Client/Customer Concentration: in general, if a business is growing, but a large proportion of their overall revenue is related to one or to a small number of very significant customers, the perceived risk of that situation is high. That risk generally lowers the value of the business. This is because if the business were to lose one of those very significant (for example: 25 percent of revenue or more) customers, the entirety of its profits (or more) could be lost. Potentially this risk could be mitigated by very long and tight contract terms, or if the purchases of that customer were of an exclusive product with no alternatives, that must be regularly replaced. Ultimately though, any customer could stop buying for a reason outside of your control, and it is uncomfortable for the financial resiliency of your business to be so tied up in that truth.
At the end of the day, business value is some sort of equation that is represented by:
Profits x Y = value
What number that Y equals is very significant. Thinking about some of the trade-offs between increasing profits and gaining value through improving parts of the business to allow for a higher multiple is not an insignificant thing. The longer your timeframe is to make those sorts of intentional choices, the more you could stand to benefit in the long run.
© YC Partners 2025
