| Correctly Pricing A Business Is Important If You | | | | strong multiple. A lot of buyers want, for example, a |
| Really Want To Sell It!As a consultant I talk to many | | | | well-established franchise, or a grocery store with a |
| business owners, brokers, and agents on a daily basis | | | | long lease in a densely populated area and little direct |
| about valuing businesses. It always amazes me on | | | | competition. Its multiple might be in the range of two |
| how some of these individuals come up with the | | | | to three times annual adjusted net income.A one or |
| values on small businesses being sold. No wonder only | | | | two multiple, on the other hand, would be associated |
| 30% of all businesses sell! In many instances no | | | | with an enterprise in which the buyer is assuming |
| consideration is given to the total picture - like will the | | | | greater risk. An example is a retail store near a large |
| available cash flow of the business be able to pay | | | | shopping area, which leaves the buyer of the smaller |
| the debt of a loan, will the deal as structured or | | | | business vulnerable to the competitive marketing |
| priced even be attractive to financing sources, "cash" | | | | activities of much larger companies. The lower |
| price vs. "note" price and how these factors figure | | | | multiple is a consequence of lower market demand. |
| into the equation!I have seen many "professional | | | | Fewer people want that kind of business.Since |
| valuations" where the price just doesn't make sense | | | | profitable distributorships and manufacturing |
| - and sellers wonder why their business for sale just | | | | companies are much sought after, it's not unusual to |
| sits there with no action!Market ApproachThere is a | | | | see them command a price upwards of four times |
| solution that is grounded in the fundamentals of | | | | annual adjusted net profit. The company in this |
| economics, and time tested in the marketplace, | | | | category providing adjusted net profit of $200,000 |
| where the influences of supply and demand ultimately | | | | might realize a selling price in the range of $800,000, |
| determine where a business belongs on the price | | | | assuming a favorable deal structure (more about that |
| scale. One economist explains this market approach | | | | shortly). Also warranting a high multiple are businesses |
| by comparing a business to a machine which has the | | | | loaded with assets-equipment, trade fixtures and |
| purpose of making money: The more money it | | | | inventory. But remember that a seller must be able |
| makes, the more it's worth. And that explains why, | | | | to establish the company's "history of earnings" with |
| for example, there is a strong demand for a very | | | | financial reports and tax returns, before the higher |
| profitable distribution business with few hard assets; | | | | price will be offered.More commonly available |
| and why it is worth more in the marketplace of | | | | businesses, such as restaurants, are priced with a |
| available businesses, than a large machine shop that | | | | lower multiple - in the one to two range - to reflect |
| would cost nearly $1 million to duplicate, but can't | | | | the abundance of this kind of business available for |
| make a living for its owner.Adjusted Net IncomeThe | | | | sale at any one time. In this case it's purely a matter |
| first category of information needed is called | | | | of supply and demand.And a company in any industry |
| adjusted net income, and is the total amount of cash | | | | that is difficult to finance, will be hard to sell. I'm |
| produced by the "money machine." It's a figure that | | | | familiar with a retail business in Northern California |
| includes the profits, the owner's salary and all of the | | | | that is not generating enough adjusted net income to |
| many cash-related benefits which are enjoyed by the | | | | support its $1.5 million asking price. Because a new |
| principals of small businesses. Those benefits can | | | | owner would have a difficult time paying off a loan |
| include the use of a company car, the company-paid | | | | that was hefty enough to swing a purchase of this |
| premiums for health, life and auto insurance, plus | | | | company, there are no lenders willing to provide the |
| personal expenditures tucked into travel and | | | | money. That severely affects marketability. In fact, |
| entertainment, subscriptions and similar business | | | | the company is probably unsalable as |
| "expense" categories. Interest expense should be | | | | presented.Importance of Deal Structure/TermsAnd |
| added to adjusted net income, along with accounting | | | | the final factor thrown into this equation is particularly |
| entries-such as depreciation and amortization-that can | | | | useful in determining the value of businesses offered |
| divert money to the owner's pocket so that it never | | | | for sale. It recognizes that the terms of a |
| appears on the bottom line of the P & L.While some | | | | transaction--in other words, how a price is paid--are |
| of these items vary from business to business, any | | | | critical in calculating that price. When sellers demand all |
| owner knows which categories of expenses in his or | | | | cash for their businesses, for example, the market |
| her financial records include sums of money that | | | | tells us that they can expect to receive about 60% |
| should be added to adjusted net income. Many | | | | to 80% of the sum they would have gotten by |
| business owners also know of cash income that | | | | taking a down payment and financing the balance.It's |
| never sees the business records in any way, shape | | | | easy to understand why deal structure is such a vital |
| or form. Some owners feel they should get credit for | | | | component in the valuation process. For a business to |
| these sums in the calculation of value. But it's a poor | | | | be affordable, the cash flow needs to be substantial |
| policy to collect unreported income and then attempt | | | | enough to support the price at the multiple being |
| to have it included in adjusted net income for | | | | used. A deal that requires a lot of cash up front, in |
| evaluation purposes. When selling, your buyer | | | | relation to the expected amount of adjusted cash |
| prospects want any statements you make about | | | | flow, will place a greater burden on the buyer. That |
| your business to be supported by evidence in the | | | | principle, translated into the language of the |
| form of accounting records and other reliable sources. | | | | marketplace, means the business will only be |
| To admit that you are doing business "off the books" | | | | appealing at a low price. If, on the other hand, the |
| not only exposes you to problems with the IRS, it | | | | level of adjusted net income supports the buyer's |
| also sets a bad tone with prospects who-if they are | | | | ability to make payments to the seller in order to |
| going to be interested in your business-- need to | | | | purchase the business-this opportunity will interest |
| believe your practices and record keeping are above | | | | more potential buyers and the result is a higher |
| reproach.Adjusted net income is usually the first thing | | | | achievable sales price.Other ways an attractive deal |
| any buyer wants to know about when investigating a | | | | structure can be used to build market appeal include |
| business; and not just the past few months' worth | | | | a delay of a few months--after close of escrow-- |
| of income. A seller should be prepared to | | | | before monthly payments on the seller's financing are |
| demonstrate a history of earnings, and have the | | | | due to begin, a low interest rate, and interest only |
| documentation to back it up.Multiplier MethodThe | | | | payments for awhile, until a new owner is able to |
| next piece of the equation comes from the | | | | build the business to more easily meet the loan |
| expectations working in the marketplace to shape | | | | obligation. Creative deal structures always help sell a |
| the multiplier-a figure which will be computed, along | | | | business and will usually command a higher market |
| with the cash flow, to calculate a rough value. The | | | | price for the business (remember it has to make |
| validity of the multiple is that it reflects behavior in | | | | sense)!Pricing a business is as much or more of an art |
| the market. There is no need to theorize about a | | | | than a science. Sellers who take a look at the big |
| proper multiplier. It's calculated by determining what | | | | picture - looking at both deal structure and price are |
| people actually pay for small businesses in | | | | usually the ones who are successful in selling their |
| California.The experience with low risk businesses is | | | | business! |
| that their high market demand is reflected in a fairly | | | | |