It’s commonly said that business valuation is more art than science. If this is true, then the practice of valuing a start-up business is squarely in the domain of the artist.

Nevertheless, entrepreneurs need to put a value on their start-ups in order to raise money, and investors need to put a value on their investments to generate liquidity. Since neither entrepreneurs nor investors are known for right-brain artistic thinking, this article aims to provide some tips for left-brain thinkers to make sense of start-up valuation.

1. You are what the market says you are. If investors are telling you that your start-up is worth $1 million, then that’s what it’s worth. You might think it’s worth more. You might even know it’s worth more because your company may have more than $1 million is liquid assets, or more than $1 million in receivables, or more than $1 million in sweat equity. But if you’re unable to raise money for your start-up with a valuation above $1 million, then you’ll have to accept the market valuation.
2. But you can also tell the market what you’re worth. Although this might seem to contradict the point made above, it’s possible to tell the market how to value your company. After all, if investors think your start-up is worth $1 million, it’s usually because of something you’ve told them. By definition, start-ups don’t have a history of financial performance on which to base a valuation. Therefore, it’s up to the entrepreneur to develop a process for valuing the company based on comparables and financial projections.
   • Comparables: Find out how much similar companies in your industry and geography are worth. You can use sites such as BizBuySell and BizQuestto determine how much businesses are selling for in your industry. If you have a high-tech or high-growth start-up, accountants and lawyers are among the best advisors to help you determine the market rate for comparable companies at your stage. In my experience, attorneys tend to overvalue star-tups, and accountants tend to undervalue start-ups, so you may want to talk to both before making a decision.
   • Financial forecasts: Although it’s notoriously difficult to forecast revenue at a start-up, you’ll need to do this to determine value-and eventually to defend your valuation. For example, if you’re starting a pet food store, your valuation and financial projections will likely be lower than if you’re starting a speculative biotechnology firm.
3. You’re not really worth anything until you’re profitable. If you’re not profitable, your business probably isn’t worth very much. That is, it doesn’t have as much liquidity as it would have if it were profitable. Many businesses cannot be sold, since there aren’t enough business buyers for every seller. Almost all unprofitable businesses cannot be sold for the same reason.

This makes valuation particularly challenging for a start-up. Since young businesses take time to become profitable, the trick of valuing start-ups is to focus on the future. First, determine how many years it will take to be profitable. A business with a long road to profitability will usually be worth less than one with a quick path to profitability. Next, determine how much comparable companies have been valued at when they reached profitability.

A company that could be worth $5 million at profitability will be worth some fraction of that number at the start-up stage, based on factors such as the likelihood of success, the time frame to exit and the quality of the management team.

It’s easy to get caught up in the excitement of valuing your company at the highest amount possible and forget that you’ll one day have to deliver on the expectations of investors. It’s also tempting to adapt your business model to maximize start-up valuation.

Be careful about overvaluing your start-up with faulty assumptions; it will only make your life more difficult-particularly if your investors have governance rights, such as positions on the company’s board.

Much like artists, entrepreneurs need to use creativity in valuing their start-up businesses. Traditional approaches to valuation based on book values and P/E ratios are akin to painting by numbers. If you want your start-up to be a masterpiece, you’ll need to use the right side of your brain as much as your left to determine value.

Who can sell a service? Anyone and everyone. Everyone is qualified because each of us has skills, knowledge or experience that other people are willing to pay for in the form of a service; or they’re willing to pay you to teach them your specific skill or knowledge.

Selling services knows no boundaries–anyone with a need or desire to earn extra money, work from home, or start and operate a full-time business can sell a service, regardless of age, business experience, education or current financial resources.

What Are the Advantages of Selling Services?

There are many advantages associated with starting your own business selling services. Perhaps the biggest advantage is you become your own boss, take control of your future, and in effect become the master of your destiny.

I’ve been self-employed for a number of years, and for me the lure of self-employment is the freedom and independence that calling the shots affords, which can be difficult to achieve when you work for others.

Operating your own business also gives you the potential to earn more money, in some instances two, five or even ten times more than you’re currently earning. Why? Simple duplication. When you work for someone else, there is only you and only so many hours in the day to work for an hourly wage or a salary.

When you operate a business, you can duplicate yourself by hiring employees and salespeople to increase revenues; you can duplicate your customers and find more just like them to purchase your services; and you can duplicate your business model and open in new geographical areas to service more customers and earn more profit. These are all things you can’t do when you work for others, and if you do, chances are it will financially benefit the boss a lot more than you.

Capitalize on Your Skills

Don’ t worry if you lack business skills and experience in areas such as time management, personal-contact selling, negotiating, bookkeeping and the ability to create effective advertisements. There’s no question these are all important skills to have, but at the same time they’re also skills that with practice can be learned and mastered. More important is the question,

“What skill(s) do you have that can be sold as a service?”

Any skill(s) you possess can be your best, and by far your most marketable, asset. If you know how to safely walk a dog, that’s a skill people are willing to pay you for. If you know how to plan and throw one heck of a party, that’s also a skill people are willing to pay you for as their event and party planner. If you know how to play the piano, this is a skill other people will pay you to teach them.

If you know how to sell products and services online, once again that’s a skill that people are willing to pay you for as an online marketing consultant. All are examples of skills that people pay other people to perform, or teach them how to learn.

Every person has one or more skills other people are prepared to pay for in the form of a service provided to them, or to learn. However, with that said, most people have a tendency to underestimate the true value of their skill sets and experiences.

You have to remember, what may come naturally to you may not come so naturally to others. Likewise, you might think your particular knowledge or expertise may be of little value, but if someone else needs or wants to learn about that knowledge, it’s very valuable to them.

Selling Services Part Time

The first option is to start off selling your services on a part-time basis, which is a good idea because it enables you to eliminate risk by limiting your financial investment. It allows you to test the waters to make sure that being self-employed is something you enjoy and want to pursue.

If all goes well, you may decide to transition from your current job, devoting more time to your new enterprise each week, all the while decreasing the time at your current job until you’re working at your new business on a full-time basis. There are many advantages to starting off part-time, including keeping income rolling in, taking advantage of any current health and employee benefits, and building your business over a longer period of time, which generally gives it a more stable foundation.

If it turns out you’re not the type of person who’s comfortable being the boss, you’ve risked little and still have the security of your job.

Of course, if your ambitions are only to generate extra money to pay down the mortgage, save for retirement, put yourself through school, or pay off credit cards, selling services part-time is the perfect choice. It’s important to do what you want to do and what best suits your individual needs. If selling services part-time works for you, then go for it.

Selling Services Full Time

You can also jump in with both feet and start your new business selling services full-time. This option would appeal to people without a current job or people who are confident about being the boss and operating a business. There’s nothing wrong with starting off full-time, especially if you take the time required to research the business, industry and marketplace.

You must also develop a business and marketing plan, and have the necessary financial resources to start the business and pay yourself until it becomes profitable.

The main downside to starting full time is risk. If you jump ship and leave your job, you risk loss of current employee benefits and have no guarantee of steady income, contributing spouses or partners excluded. The upside to starting off full-time is potential rewards, including the opportunity to make more money than you can at your current job, and to gain control of your future.

Your decision to operate your new business on a full-time basis will largely be determined by your current financial situation, your own risk-reward assessment, and your goals and objectives for the future. Jumping in full-time will appeal to the true entrepreneurial mindset–people who prefer to blaze the trail rather than follow behind in the wagon train.

Selling Services Seasonally

Another option is to start a seasonal business selling services, which can be operated with a full- or part-time effort. But most are run full time to maximize revenues and profits over a normally short time span. Examples of seasonal businesses selling services would include snow removal in winter, yard maintenance in summer in northern climates, income tax preparation service in spring, and serving as a vacation property rental agent. Just about any business can be run seasonally or occasionally, but some are obviously better suited than others.

A seasonal venture will appeal to people who want the ability to earn enough money during part of the year in order to do as they please with the remainder of the year–travel, pursue education, or work a job in another season.

The potential to earn a very good living operating a business only part of the year is a genuine opportunity, as proven by the thousands of people who are currently doing it. The main downside to a seasonal business, especially one that can be operated year-round, is that you don’t want to spend thousands of dollars and hundreds of hours promoting your business only to shut it down for half the year, sending current and potential customers running to your competitors while your business is closed.

Selling Services to Supplement Your Retirement

The fourth option is to sell services to supplement your retirement income or just to have fun and stay active in your golden years. Retirement businesses have become extremely popular in the past decade, mainly because the cost of living has dramatically increased, often outpacing wages and retirement savings.

The result is that many people head into retirement needing a little extra income to cover expenses and provide an adequate lifestyle or to maintain their pre-retirement lifestyle.

People are living longer and much healthier now than in decades past, and because of this many are seeking new challenges; starting and operating a business is a way to stay active physically and mentally. Older people also have a proverbial ace up their sleeves when it comes to starting a business and selling services: a lifetime of knowledge and experience that can only be acquired by spending lots of time on this planet.

Because of the value of these skills, many people are willing to pay big bucks for them. This is why many people who are reaching or have reached retirement age have chosen to start a consulting business selling their experiences, knowledge and skills for the benefit of their clients.

Before you decide to get into business for yourself selling services, there are two issues to consider regarding financial compatibility–income and investment money. First, when deciding what type of service to sell, you have to consider how much money you want to earn and how much money you need to earn.

If you need to earn $75,000 per year to pay your personal expenses, there is little sense in starting a dog-walking service. Perhaps there are a few dog walkers earning this much, but it’s not a realistic expectation. How much money do you want to earn–that is, how ambitious are you?

Again, you must be realistic and relatively sure the service you choose to sell has the potential to generate enough income to live on in the short-term, and the potential to match your income goals in the longer term.

Income doesn’t have to factor into the business startup equation for everyone. If you want and need to earn only a little money from a part-time or retirement business, the income equation will not factor as heavily as other issues.

The second big financial compatibility issue affecting your decision about which business to start or purchase is the amount of money needed to start or purchase the business. Not only will you need to have or have access to the investment needed to get rolling, but you’ll also need extra money for working capital to cover day-to-day operating expenses until the business achieves positive cash flow. This can take a week, a month or even a year.

Ultimately, financial compatibility is important when starting a business and deciding what services to sell. If you cannot afford to start the business and don’t have the financial resources to pay operating expenses and your wages until the business can break even, you’ll probably have to look at alternative options, such as starting part time, choosing a different business to start, or waiting until you have acquired the money needed to get started.

Finding a Good Match

You also must be well suited to start and operate the business and services you’re considering providing. You and your business must be a good match. You may have an interest and even experience in a specific business or in providing a specific service, but that doesn’t necessarily make it a good match. Here are a few points to consider when determining a good business match.

• Do you have the financial resources to start or purchase the business, and enough money to pay the day-to-day operating expenses until the business breaks even and is profitable? If not, it’s probably not a good match, and you should consider alternatives.
• Does the business have the potential to generate the income you need to pay your personal expenses, and does it also have the potential to generate the income you want to earn? This is very important because if you can’t pay your own personal bills, you’ll soon be in trouble. And if, over time, you can’t earn the income you want to earn, you’ll lose interest in the business–a recipe for disaster.
• Are you physically healthy enough to handle the physical strains of starting and running the business? If not, you may end up having to hire people for the job, which can be problematic if the business revenues aren’t there to support both management and employee wages.
• Do you have experience in this type of business or service, and do you have any special skills that can be utilized in the business? You can gain experience and knowledge on the job but skills that can be utilized and capitalized upon right away are extremely valuable.
• Are there any special certificates or educational requirements to start and operate the business, and are these readily available? Find out the upfront costs associated with these, how they can be obtained, and the time frame needed to obtain specific certificates. Training and certification shouldn’t be viewed negatively because often the return on time and investment is substantially rewarded financially. Anything worth doing is worth doing well.
• Will you enjoy operating the business, and does it match your personality type and level of maturity? This is very important. If you don’t think that you would enjoy it, then don’t start. Again, the loss of interest in a business is almost certainly the kiss of death. You can’t stay motivated and rise to new challenges if you don’t like what you’re doing.

It’s an age-old question that faces every entrepreneur: What do I pay myself? There are a lot of different ways to answer that, but the two most common are:

1. Pay yourself enough to get by. At least during startup until you are operating in the black. The argument here is to minimize your overhead in order to decrease the amount of capital required to make your business a success. Also, by reducing your overhead, your net loss will decrease or your net profit will increase, providing the business with lean operating requirements until it is well established.
2. Pay yourself what you are worth. Build that into your business plan so you have an accurate portrayal of how much capital you will need in order to finance your business. By paying yourself what you are worth, you aren’t painting an artificial portrait of the business that will change once you reach the black–operating costs will remain the same.

So how do you know what is enough to get by and what you are worth? You have to do some planning and simple mathematics, and then budget that amount into your income and cash-flow projections so that you know how much operating capital you will require during the formative stages of your company’s development.

What happens when you reach break-even and grow beyond that point? There are many factors that go into the equation, such as legal form of operation and tax requirements. You need to balance your needs against what you feel you are worth, what you need to get by, what the business will be able to sustain, and how your income as well as the business will be taxed.

Projecting Your Salary

As we mentioned, there are two methods you can use to determine your pay during startup. The first is paying yourself enough to meet basic living requirements. Depending on your situation, that means enough income to cover your bills, food and other miscellaneous living expenses. Strike all other discretionary items from your life for a while and get used to just the bare necessities. If you are used to dining at fine restaurants seven days a week, get used to going down to the local McDonald’s maybe once or twice a week.

To begin planning your pay, you need to put together your own personal financial statement that lists all your living expenses and any credit cards with outstanding balances as well as short-term and long-term loans. This may be one of the most difficult things you’ve ever had to do because you don’t want to leave anything out. You want to make sure that your income from the business will be enough to cover your expenses.

The personal balance sheet should include a list of common items you’ll need to consider when determining your monthly living expenses. Generally, if you can pay-down any debts before going into business, you’ll not only decrease the amount of income you’ll require each month, but also improve your personal net worth, which is important when it comes to borrowing capital to fund your business.

Once you’ve listed amounts for each of the items on your monthly budget, add them all together. This is the amount you will need to pay yourself in order to meet your basic requirements. Remember when putting together your list to include all your expenses. That doesn’t mean just monthly, but quarterly, semiannual and annual expenses. You must provide yourself with complete information. After all, you will be living on this income for at least six months to a year.

The other system from which you can project your salary is basic worth. How much do you feel you are worth? That’s a very subjective question. After all, what you feel you are worth may not be what your value is on the market. Of course, many people go into business for themselves because they want to achieve a degree of financial security for themselves and their families. Naturally, you’re going to assume that you will pay yourself a basic minimum of what your current market value is plus a little more. And that is exactly how you will set up the equation to determine what your monthly draw will be from the business.

To determine your basic worth, start by writing down your current salary or hourly wage. That is what your market worth is at this point in time. This is what you want to make at a minimum going into the business. But market worth isn’t basic worth. There is a difference. Basic worth is your market worth plus a percentage increase based on three to four times the rate of inflation.

Why is there a percentage increase from market worth? As we mentioned, market worth is a minimum, a starting point. It doesn’t take into consideration the increased responsibilities of running a business and your value to the business as its owner. With these factors taken into consideration, your basic worth is determined using the following equation:

MW/12 x (I x 4) = BW

In this equation, market worth (MW) is your total annual pay minus any bonuses or overtime. Divide the annual market worth by 12 to get a monthly amount. Then multiply this by the inflation percentage (I) multiplied by 4.

For instance, suppose you are making $15 per hour at your current job. At $15 per hour, your annual pay would be $31,200. Your annual pay of $31,200 would then be divided by 12, resulting in a monthly income of $2,600. At the time you are determining your basic worth, the rate of inflation is four percent. Multiply four by four, and the percentage which you will add to your current monthly income is 16 percent. Your basic worth would be $36,192 annually.

Of course, these are just recommended models to use when determining what you will pay yourself during the period of startup to break even. You can use any type of system you wish. The idea is to provide you with a realistic figure that’s fair and equitable.

Break-Even and Beyond

Determining your salary during the planning stages of startup is important because you need to include your income in the financial statements you will produce in order to obtain financing for your business. Even if you are financing the venture yourself, you need to have this information in front of you; otherwise, your overhead won’t be practical and any income, break-even and cash-flow projections you will perform will be inaccurate.

Any bank or investor looking through your plan will check your financials very carefully. They’re going to look at these projections to make sure you can repay the loan from the profits of the business. If they hold equity in the business, they need to determine how great a return they can expect from their investment. They’re going to check the cash-flow projection to make sure you have enough to cover your own draw and living expenses until the company is profitable, unless, of course, you have a separate income.

Keep in mind that during the first year of business, it typically takes three to six months to break even. Once you reach break-even, though, do you change your salary? If you think you can, then you will make one of the most common mistakes an entrepreneur can make.

Just because you’ve reached break-even, that doesn’t mean your company is profitable, or is even stable. If you’re paying yourself just enough to get by, raising your salary is going to increase your overhead, which will require a greater amount of revenue from the business in order for expenses and income to match. In other words, you’ve just thrown your business into the red again. If you’re paying yourself your basic worth, then you shouldn’t need to raise your salary, at least for a while.

After you’ve reached break-even, the best method to increase your pay is to tie any income above your fixed salary to the growth of the business. Therefore, if the company grows 10 percent during the first quarter after break-even, take your base salary and add a 10 percent bonus to it.

Continuing with this example, if your base salary is $3,016 per month as determined in our example of basic worth, you would multiply that number by three (the number of months in a quarter) and add 10 percent. Therefore, you have:

3,016 x 3 + 10% = $905

You would give yourself a bonus of $905.

After your first full year in business, once you’ve passed break-even, reevaluate your business to determine its annual growth and increase your salary accordingly. As an example, suppose company sales have grown 50 percent during the first year after break-even. Your current salary level is $36,192, based on the basic worth example. Multiply that salary by 150 percent and you will come up with your new annual pay, $54,288. You can retain the bonus income after the first year of break-even if you like. After all, why not compensate yourself for the increased performance of your company?

There are, of course, other factors you need to consider when determining pay. For instance, what happens when the rest of overhead, excluding owner compensation, grows faster than the rate of sales on a percentage basis? Most of these expenses are required in order to operate your business. Sure, you may be able to trim a little fat from the budget by removing any discretionary purchases, but the fact remains that if overhead grows at 12 percent, and sale grow 10 percent, it is only a matter of time before you find yourself in trouble. By increasing your base salary by 10 percent, the rate of sales growth, you are only hastening this crisis.

In order to keep your total overhead, including owner compensation, at a comfortable level in relation to income, you will have to take that rise in overhead into consideration when you determine your salary level. To do this you need to determine how much your overhead is, excluding your salary. For instance, suppose your annual overhead minus owner salary is $180,960, your salary is $36,192, and sales are $312,000. If you add during the first year after break-even, the company’s sales grow by 10 percent of sales. Now, but overhead minus owner salary grows by 12 percent to $202,675, or about 60 percent of total sales. Your raise in pay cannot exceed 70 percent, so you will be unable to give yourself a 10-percent raise unless you want to cut into your profit. Instead, you would give yourself a four-percent raise for a total of $37,600 annually.

Keeping your costs under control means checking rapid growth of your overhead costs. But no matter what you do, overhead will rise on annual basis due to inflation alone. Your objective is to try and keep it in line with the growth of sales.

A lot of people fail to realize that when you’re self-employed, the legal form under which you operate your business directly affects the way the IRS views your tax status and, therefore, will have some bearing on how you pay yourself.

The easiest way to get into business is as a sole proprietor. A sole proprietor doesn’t have any partners to worry about, nor a corporate identity to hide behind. As a sole proprietor, the buck stops at your desk and nobody else’s. If you get tagged with a lawsuit, you face the liability. It’s as simple as that.

On the other side of the coin, if your company does well, you reap the profits. Under a sole proprietorship, profits from the business and your personal income are treated the same by the IRS. There is no distinction.

After deducting all your overhead expenses on Schedule C of Form 1040, the resulting profit is your income and you are taxed on that portion, including a tax for social security under the Federal Insurance Contributions Act.

A partnership is a totally different vehicle from the sole proprietorship in terms of operations, but from the point of view of the IRS they are practically the same. Any profit generated through a partnership is treated as personal income. Instead of completing Schedule C of Form 1040, however, partnerships must file Form 1065, U.S. Partnership Return of Income.

If your business is organized as a corporation, you will get paid a salary like other employees. Any profit the business makes will accrue to the corporation, not to you personally. At the end of the year, you must file a corporate income tax return.

Corporate tax return may be prepared on a calendar- or fiscal- year basis. If the tax liability of the business is calculated on a calendar year, the tax return must be filed with the IRS no later than March 15 each year.

Reporting income on a fiscal-year cycle is more convenient for most businesses because they can end their tax year in any month they choose. Pursuant to the 1986 Tax Reform Act, a corporation whose income is primarily derived from the personal services of its shareholders must be a calendar year end for tax purposes. In addition, most Sub-chapter S corporations are required to use calendar year ends.

The salary you receive from the corporation is, of course, reported as your own personal income on Form 1040. As the CEO of a corporation, you’ll be able to plan your salary with an eye toward tax rates. You may be able to set up a staggered fiscal year, differing from the calendar year by which individuals are typically taxed.

How can you achieve this? Pay salaries that will absorb whatever profits there are in the company. There is a limit to how much of this you can do, and in most states you have to document the process with appropriate resolutions and directors’ meetings. But for most small companies not making a tremendous amount of money, it makes sense to pay income out of the corporation in the form of salary.

There is a danger to this strategy, especially when it comes to awarding big bonuses to yourself. If you’re the owner of a small, privately owned C-corporation, the IRS will look closely at returns to determine if there is “excessive compensation” to lower the tax liability of the company. If the IRS determined the bonus, in addition to your regular salary, is too large, they’ll disallow the deduction of the bonus as an expense to the corporation. In addition to the loss of the deduction, increasing the amount of tax to be paid, the IRS will also charge you interest and, more than likely, penalty fees.

No matter which legal form you choose, it’s vital that you discuss this decision with your tax accountant or attorney to make sure you’re operating legally and getting the best deal on your taxes.