Post written by: Kim Cedarstrom residential/commercial Realtor©, Consultant firstname.lastname@example.org
In the previous blog I covered the four ways to value a business when selling/disposing of it. Here I’ll go over the most common way to determine the market price of a business “Sold as a Going Concern”. What is commonly called a “business” can actually be comprised of up to three distinct parts – the “business”, the inventory, and the real estate (if it has any). The total selling price is the total of the three. The real estate is valued by standard industry methodology. The inventory is priced at the current wholesale value or the cost of the inventory. This leaves the task of setting a market value for the business entity. There are many ways to value the worth of a business. The most commonly used valuation methodology for small businesses is using an earnings approach based on the total cash flow to the owner. This figure has different names – owner’s cash flow, seller’s discretionary cash, and Seller’s Discretionary Earnings (SDE). An earnings approach includes the value of furniture, fixtures, and equipment in the price. For our purposes I’ll use the term SDE. This approach uses total cash flow that benefits the owner of the business, including salary, benefits, depreciation, etc. All of this is then added to the profit (if any) that the business produces to arrive at a total we’ll call SDE. Multipliers are derived from comparable regional and national sales and differ for each type of business. SDE is calculated by adding the owner’s salary to Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), then a multiplier is applied. So basically the magic formula is:
(EBITDA + owners salary = SDE) x multiple = selling price. Now the inventory and real estate must be added to arrive at the total selling price.
OK, so how’s your headache? That’s a lot to digest in one big bite. Here’s what I’ll tell you as I do my clients, don’t get too wrapped up in the methodology. That’s my job. I put forth the explanation only to give a basic idea of how the system works. The best thing you can do is to consult a professional to do this work. Many other variables will enter into the pricing scheme such as ease of duplication of the business, lifestyle considerations, and synergistic situations such as buying out a competitor. Another big thing to know is that there are some few things that you should do prior to putting your business up for sale. Again, consult a pro and if at all possible plan ahead. A time frame of three years is recommended to get your business ready to sell to maximize your return.
There are a few exceptions to the above method. If the business relies on the real estate as the “inventory”- hotels, inns, marinas, B&B’s, etc. – then the business value is primarily in the real estate. If the business is based on rental income, then an income approach is used to price the business.
So, there it is. I think the best thing to say here is don’t try this at home. Selling your business is a big step. Many people (and sometimes families) have spent their careers and fortunes in developing and operating a business. They are often so involved and invested in the framework of the entity that they have a hard time looking at the disposition of the business in an un-impassioned and unbiased way. Understand one thing: selling or buying a business is just like any other transaction, it requires two willing participants and is impersonal. Try to separate yourself from the process. It is really important to try to put your self in the other person’s shoes in the transaction. People who buy or sell businesses are almost always “businesspeople”. They are experienced knowledgeable folks who for whom this “isn’t their first rodeo”. Give them some credit and make it worth their while to do business with you. Many times the best potential buyers are from the same industry—often competitors.
Next time the big question- Buy a business or start your own?
Call or email me with any questions or comments. I would be glad to hear from you.
Kim Cedarstrom is a licensed Commercial and Residential Realtor© and consultant living in Meredith NH. Having spent a lifetime founding, operating, and selling his own businesses in the Lakes Region of New Hampshire, he now offers lakefront and residential real estate services in addition to commercial property and business sales. Contact Kim at email@example.com or at 603-520-6609. Initial meetings are always free of charge.