A Seller's Guide: What Is My Business Worth?
One of the most common questions a Business Broker will face when talking to an owner who is considering the sale of their business is ‘What is my business worth?’
There are many ways in which to value a business, and many different size of businesses, but for the purpose of this article we will focus on companies with revenues of less than $1M that are valued using the market approach method.
The Market Approach Method
Put simply, the market approach is similar to the comparable method used in real estate and is based on the principle that businesses that are alike in size and industry will sell for similar amounts. Business Brokers have access to many databases they can use to research multiples of gross sales and earnings to compare your business to others in your market. The market approach method is very reliable in most cases and will give you a strong indication of the value of your business.
Typically, businesses are valued as a multiple of the owners earnings.
Calculating Owners Earnings
The earnings of the owner in a small business are called many things – Sellers Discretionary Earnings (SDE), Owner Benefit, Discretionary Earnings, and Adjusted Net to name just a few!
Without getting overly complicated, the above all essentially mean the same thing. An owner’s benefit is made up on the following items:
- Net Income (pre-tax), plus
- Owner’s salary (one full time working owner)
- Owner’s perks and benefits
- One-time extraordinary or non-recurring expenses
Most owners of privately held companies try to minimize their profits to limit the amount of taxes due. Whilst this may benefit them during the time they own and run the company, it is not helpful when trying to sell, as at this point you are trying to show the ‘true’ earnings of the business to demonstrate to potential buyers what they can really expect to earn.
Quantity of Earnings
In order to show the true value of a business it is vital to have good books & records, or at the very least be able to find and prove the earnings.
Being able to adequately prove the quantity of the companies earnings is essential and is a driving factor in the multiple that will ultimately be applied to the sale. Businesses with higher earnings will typically sell for more money (although this is not always the case as you could have a business with revenues of $1M that generates an owner benefit of $100’000 as opposed to a business with ‘only’ $500’000 in revenue that generates $150’000 in owner benefit).
Quality of Earnings
There are a number of factors to consider when looking at the quality of earnings. As with quantity, good books and records are key to proving the earnings but outside of that the following items will be of importance to a buyer:
- Customer & vendor concentration
- Size of the business
- Key employees
- Market share
- The value and condition of any assets the business holds
The better position the business is in with each of the above categories, the more it will see a strong multiple being applied to its valuation.
Ease of Transfer
This is a sometimes overlooked but critical part of the sale of a business. Are there licenses, contracts, or issues with the landlord that could impact the buyer being able to take over the business? Small business are typically sold through what is known as asset sale, but issues with transfer can lead to a stock sale being required, which is when things get more complicated.
As a seller you should be aware of any potential problems with the transfer of your business and should discuss these with your Business Broker early in the sale process.
So, the key question that every seller wants to know once their SDE has been calculated is ‘What is my business worth?’
As mentioned earlier, valuations of businesses with revenues under $1M are typically calculated as a multiple of SDE and so knowing what multiple is to be applied to the business will give a seller their potential asking price.
It should be said that Business Valuation is an art not a science, and often times two different brokers will come up with two different values for the same business. Using statistical analysis of past sales of businesses gives an average multiple of between 2 and 3 times earnings. This average multiple has remained consistent for the past several years.
However, this figure is not set in stone and can vary from business to business. It is dependent on a number of factors as we have already discussed and usually has a direct correlation to the size, quality, and verifiability of your owner’s benefit. A business with declining or flat figures, poor books, and low profit will likely produce a low multiple, whereas great books, a growth trend, and a healthy profit will drive a higher number.
For owners looking for a guide as to the value of their business, 2 times earnings is a general rule of thumb that will at least give you an idea of the potential value. Often times, an owner will reply to the valuation number with the statement ‘Is that all you think it’s worth?’ Whilst delivering bad news to an owner is never an enjoyable thing to do, it will at least give them an honest picture of where things currently stand, at which time a good Business Broker will be able to help and advise the owner on what to do over the coming months/years to improve the valuation of their business, or to at least explain in more detail why the number isn’t what they were expecting.
In summary, every business is different and so whilst the guidelines covered in this article will help in arriving at a valuation, if you are considering the sale of your business you should speak to an expert to get a more detailed analysis of your particular situation.
For a more detailed discussion about valuation or any advice on selling your business call me on 407-989-6893 or visit www.theharrisongroupfl.com
The Harrison Group at Rockrose Realty Inc.