Keeping It Real Whether You’re Buying Or SellingPrinted in: The Public Record, February 2012
There are several industry-accepted methods used to arrive at the value of a business. Just rattling these off can make one sound, well let’s just politely say informed.
1. EBITDA– Earnings before depreciation (and other noncash charges), interest and taxes.
2. EBDT– Earnings before depreciation (and other noncash charges), and taxes.
3. EBIT– Earnings before interest and taxes.
4. SDE– Seller’s discretionary earnings.
Just to make matters more interesting, a multiple, typically between 0 and 4 depending on the type of business, is then applied against the earnings to arrive at a value. It quickly becomes quite convoluted, yet the reality is that most businesses sell at a price that is market-driven based on a percentage of the business’ current sales.
In my 10 years of valuating small businesses I have found that all these methods will pretty much get you to the same number. However, unless the business is a huge conglomerate, the best approach is the Seller’s Discretionary Earnings method, better known on the street as “Cash Flow.” By using this common sense approach, it seems both buyers and sellers have an easier time quickly grasping the value.
An examination of the Profit & Loss statements will determine the SDE, or cash flow. By adding back many of the expenses that reflect the current owner’s personal allocation of the cash in the business, which would likely be different figures for you, you’ll arrive at a true picture.
Add-backs to consider include profits, depreciation and amortization, interest fees, taxes, non-recurring expenses (such as new equipment) and the owner’s total compensation (including draws, payroll, auto expenses, health and life insurance plus any discretionary expenses.
I find most businesses sell from 1 ½ X to 3 X the cash flow. Let’s say a business is showing an annual cash flow of $50,000, generally a selling price in the range of $75,000 to $150,000 (plus inventory) would be typical. To better pinpoint the price within that range you’d want to consider the added value of some additional factors such as the number of years in business, competition, the location and lease terms, the industry trends for the business’ product or service, trade knowledge and seller financing.
Pure and simple, many a small business buyer is out to buy themselves a job. A quick check of the want ads won’t yield much for someone who just wants a reasonable income in the $50,000 to $150,000 range. Being able to quickly asses the business’ value makes it easier to navigate businesses listings and zero in on one that will meet your needs.
As a buyer, keep in mind your vision and how that translates into the growth of the business you’re considering. Buyers infuse fresh energy, personal experience and their unique stamp often resulting in a spike in sales. I like to call this the end of “tired eyes” syndrome, an affliction that often strikes the long-time business owner. When décor becomes dated, remodeling & repairs are deferred, and even new marketing venues are not pursued- it really is time for a change. Marketing strategies, window displays, product lines, websites and such, must all be working optimally to draw in the customers. I recently sold a dress shop in downtown Palm Springs that demonstrated all the symptoms. The new buyers proved me right when they refreshed the overall look, the product lines and the displays, and in a very short period saw a sales increase of 4 ½ X. Bear in mind the value YOU will bring to the table and what you are willing to pay to have that opportunity to work your magic.
The moral of this story is that mind-boggling methods aside, the selling price is what a willing seller and a willing buyer can agree on.
Robert Hughes is a commercial broker and president of Hughes Properties, Inc. in Palm Springs. An MBA from USC, Hughes has a wide variety of entrepreneurial experience with the personal ownership and sale of over sixteen businesses, including founder and publisher of Orange Coast Magazine. Additional business tips can be found at www.hughesproperties.com.