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