As with real estate, the value of a business is primarily based on what comparable businesses have sold for, in same business category, in the recent past, with a similar owner benefit range — also known as seller discretionary income — and geography.
From the comparable owner benefit range, adjustments can be made up or down, based on customer sales concentration, and the sales and owner benefit trend (up or down, and at how fast a rate of increase or decline).
To determine the multiple of earnings, divide the asking price by the amount of owner benefit. As the owner benefit increases, so does the multiple.
Not all businesses have the same multiples at the same owner benefit range. As an example, a business that is mostly tied to the seller and the seller’s relationship with customers or clients, such as a professional practice, will have a lower multiple. Businesses with middle management typically command a higher price. That is why it is smart to establish middle management as the time to sell approaches — to distance the seller from the customers and make it easier for the business to make the transition to new ownership.
A lot of “add-backs” — non-business expenses a buyer will not incur — can be a negative or takeaway to the multiple to be applied. As the time to sell gets closer, it is smart to minimize this type of practice.
A single item that takes away the most value is poor accounting records, which requires a lot of explaining. The seller can rationalize it to him-/herself, but it will take away value for multiple reasons, including the ability to get the most-favorable financing terms from a bank. Banks just don’t like incomplete “messy” records.
It is important to be realistic about an asking price. it is advisable to base the asking price on some form of logic, such as what other like/comparable businesses have sold for. BizBuySell.com, the largest marketplace for buying and selling businesses, says that over 90% of businesses don’t sell. Experience shows the reason for this is mostly due to grossly overpriced businesses.
There are exceptions for businesses being worth more than the norm. Examples of this are a one-of-a-kind, a niche business, being first to the market, or a business with super-high demand and few competitors, providing a trend for driving sales/profits through the roof.
When you finally get around to selling, don’t be surprised to find your business is worth much less than what you were thinking of asking if you have not pre-planned. At that point, it is almost too late. It is very smart to have an experienced business broker/intermediary coach you on what can be done to get you the best price possible, as far in advance as possible. A few years before selling is a good rule of thumb.
Whether you’re a seller or a buyer, if you would like a confidential conversation about how to prepare, contact me on my cell, 954-579-4687, or by e-mail at firstname.lastname@example.org. I have been doing this for more than 45 years. Google me and Dolan Sales, Inc. My LinkedIn profile is at http://www.linkedin.com/in/dolansales.