What is My Business Worth?
Welcome to Business Tips With Michael Tobian. Today we will be examining the question “What is My Business Worth”
Every business owner wants to know what the value of their business is and few of them have any clue. Today, I’ll give you a little overview of how we help potential sellers know what their business will likely sell for.
I’m going to hit on the following topics today:
- Valuation Methods
- Profitability
- SDE vs. EBITDA
- Adjustments and add backs
- Equipment, Inventory and Real Estate
- Sanity Checks
- Sellability
- Other factors
There is so much more to this topic than what I’ll be covering, but I hope that after watching this, you will have a good idea of the basics.
Keep in mind, every industry is different, so I’m going to be going over some generic information that applies to most businesses. Some unique businesses have industry specific calculations that they use that are unrelated to what I’ll be discussing. Because each industry and business is different, determining what your business is likely to sell for, requires some research. If you are interested, I’d love to take a look at your business and give you an idea of where you are at. Feel free to reach out to me at my website, listed below in the description. Let’s get into it:
Valuation methods:
When my team and I prepare a broker’s opinion of value for a client to help them come up with an asking price, we look at a few different valuation methods and present them to our client. The first one we look at is what we call “rules of thumb”. There are resources available to people in our industry that analyze what price ranges different kinds of businesses sell for. My team and I always carry the latest version of a book called the Business Resource Guide as a quick reference to these general rules of thumb. The next thing we do is look at comparables or comps of other similar businesses that have sold. Other industries use comparables as well. For example, when residential real estate agents advise their clients on an asking price, they will look at what similar homes in the area are selling for. We do this with businesses; however, with businesses, these comps are much harder to come by because sellers don’t disclose publicly what they sold their business for. So we get our comps through a cooperative database of reported information from other business brokers about businesses that they have sold. Confidentiality is a big deal in our industry so the database doesn’t disclose the names of the businesses sold but gives lots of information about what kind of business it is and what it sold for as a percentage of revenue, profit and things like that. After we look at comps, we consider other possible valuation methods, if applicable. We might even take cap rates or industry specific valuation methods into consideration. Finally, we use what I feel tends to be the most accurate method. Our own experience. We have sold so many businesses that we have a good feel for what different kinds of business will sell for. We can also look at comps in our own database of businesses we have sold. This last method is, of course an opinion. But, it’s an opinion from people that are in the trenches selling companies regularly. The advise of a quality business brokers can be invaluable.
Profitability:
A business that is making money is usually going to sell for a multiple of the profitability of the business. When I advise my clients on an asking price, I’ll usually give them a range based on an appropriate multiple. They may decide to list it on the lower or higher side of that range, depending on how motivated they are to sell it, or their timeframe. The multiple that is considered tends to be industry specific and relative to their profit. Other factors sometimes influence this as well. For example, if a business is a one man show, it is unlikely to sell for the same multiple as a similar business that has process in place and a team of people running it. I once sold a locksmith business that was literally just a guy who was a locksmith. The person who bought it learned the trade and took over his business. It didn’t sell for a very high multiple because the guy sort of just bought himself a job. If he would have had more staff and an organization, I suspect it would have sold for a higher multiplier. In any case, we use a multiplier of a business’ profitability
SDE vs. EBITDA:
The next question we should ask ourselves is, how do I calculate profit for the purposes of business valuation. Many people have heard of the term EBITDA. It stands for Earnings Before Interest, Taxes, Depreciation and Amortization. This is a standard way of ascertaining a businesses’ profit potential for a new buyer taking over. An EBITDA number reflects the profitability of the business with these adjustments that I mentioned above. If the business has a manager that is running it, the manager’s salary is included as an expense. If the owner is managing, then a reasonable salary for the owner is factored into the expenses. Another way of analyzing profit is through what we refer to as SDE, which stands for Seller’s Discretionary Earnings. This is sometimes called SDC or Seller’s Discretionary Cash. This method looks at the profitability with those same adjustments as EBITDA; however, SDE assumes the owner of the business is a working owner and any dividends or salary of the owner is considered profit. So, if the owner gives themselves a salary, that expense is added back into the profit. Sometimes it makes sense to use EBITDA when considering the businesses profit and sometimes it makes sense to use SDE. Each method will consider a different multiple when valuing the business. A business owner may put $100,000 into their pocket at the end of the day but their EBITDA may be less than that due to their actual salary being an expense. So that business may use a multiplier of 3-5 times their EBITDA but only 1-3 times their SDE. The reason this is important is, a small business may not be making enough money for a manager’s salary to even be a consideration. The buyer will just be running the business themself and they only care about the bottom line. How much money is this business putting in their pocket at the end of the day. A sizable business may require a manager. The buyer isn’t buying themselves a job. Rather, they are buying an investment and they need that manager to stay. Most Main Street businesses use SDE and most midsize to large businesses use EBITDA. If someone is buying a small business, they usually are going to work in the business and they just want to know how much money is going in their pocket at the end of the day. The distinction between SDE and EBITDA is important. I was once showing a business owner some comps and he said he had done some research that said his business was should be priced at a higher multiple. We looked up his source and it was referring to EBITDA. There was no conflict in the multiple. He had just misunderstood the difference between EBITDA and SDE.
Adjustments and Add Backs:
Buyers are eventually going to want to verify the numbers that they have been giving during a due diligence period by looking at the business tax return. For that reason, the financials we present to a potential buyer during the sales process show what is on the tax return as well as an adjusted income statement that add certain expenses back into the profit. Tax returns don’t always give an accurate picture of what a business is generating in benefit to the owner. Unnecessary expenses, one-time expenses, owner benefit expenses, non-cash expenses that won’t necessarily apply to a new owner like deprecation, amortization, Interest and taxes are shown as adjustments to a buyer. Because we show these adjustments to the tax return numbers, there are no surprises when a buyer uses the tax returns to verify things. When I’m working with a buyer, we go over these adjustments in detail to make sure we get them right.
Equipment, Inventory and Real Estate:
The value of Inventory and Real Estate owned by the business is typically added on top of the value of the multiplier used. The reason being is this: Inventory needs to be continually purchased by the business and sold to customers. They can either buy it from the previous owner or buy it from their wholesaler. It is a separate consideration. In regards to real estate, a business is likely to have either a real estate mortgage or a rent expense. Often times, the expense is a similar financial burden. In many cases, it is more advantageous for the business to have an actual mortgage as that turns into a real estate investment. Equipment is a different story. Many sellers are surprised when I tell them the value of their equipment makes little to no difference in the overall value of their business. If we analyze a businesses value based on it’s profitability, the equipment was necessary to produce that profit. It’s a part of the calculation already. An exception to this idea is if the value of a business’ equipment is more than the investment value of a business based on performance. For example, if I own a manufacturing company that is making $100,000 per year in profit but we can sell the equipment for 10 million dollars, the value of the business is going to be the 10 million dollars. In these situations, I usually advise my clients that I may not be the best person to sell their business. They may be better off getting advice from someone that specialize in selling manufacturing equipment, or restaurant equipment, or whatever kind of equipment they have. My expertise is selling ongoing business operations.
Sanity Checks:
Regardless of what valuation methods we use in our analysis, an asking price needs to pass certain sanity checks. Oftentimes I’ll look at the asking price and put myself in a buyer’s shoes and see what challenges we may face. If I assume that a buyer is going to put 15% - 20% down on an SBA loan to purchase a business, is the business making enough profit for the buyer to provide an income for themselves and repay their loan. What does their risk look like? Do they have so much inventory that it is putting the asking price in a range that doesn’t make sense financially? This step is all about determining if this is going to make practical sense for a buyer
Sellability:
I highly recommend checking out my video called “is my business sellable”. I go over some challenges that many business owners face with the sellability of their otherwise wonderful business. Often times these issues are solvable. We cover things like customer concentration issues, keeping good books and records, making your business turn-key, separating yourself from the business and more.
Other Factors:
I really take some time to learn about a business before I offer a broker’s opinion of value because there are sometimes nuances that are unique to that business. For example, I may be looking at a business that isn’t worth all that much money but they have a very valuable piece of intellectual property. Or, maybe a business is making a lot of money but is experiencing a decline in performance every year. That will affect things significantly. Maybe a technology business is selling an outdated product or an online lead generation business is conflicting with a recent major google algorithm update. Perhaps a business has a high level of residual or passive income. Lots to consider here so getting a good opinion of value from someone that really knows what they are doing is a great idea.
Thanks for listening today. I know that is a lot of information. What is funny is, I feel like I really just touched on all of this at a surface level so again, please reach out if you are interested in selling your business and let’s take a look at it. Subscribe and follow for more info in the future about selling your business. Thanks for watching!