Preparing to Sell Your Business Part 3- Valuation

Business Valuation

Selling a business is both art and science, and in no other area is this more evident than the business valuation. While every seller wants to achieve maximum value, setting an asking price that is too high might signal to buyers that you may not be serious about selling.

While there are a number of methods used to value a business, the most common formula for smaller transactions is a multiple of seller’s discretionary earnings (S.D.E.). This type of market-based valuation involves recasting profit-and-loss statements by adding back  interest, taxes, depreciation and amortization to arrive at Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).Now add back discretionary items such as owner’s salary, perks, and nonrecurring expenses resulting in  the S.D.E. of the business.

Now it is time to arrive at an appropriate multiple. A number of variables play into arriving at an appropriate multiple including:

·         Continued earnings risk

·         Company history and stability

·         Growth projections

·         Past earnings momentum

·         Competition

·         Cost of business expansion

·         Barriers to entry

·         Customer concentrations

·         Management and key employee retention

·         Location desirability and continuation

·         Facility operational efficiencies

·         Capital expenditures

·         Financing availability

·         Industry strength

·         Environmental risk

·         Alternative investment returns

·         Economic conditions

This is where a professional business broker can provide assistance to assessing your business in these terms and providing an appropriate multiple.

It is also important to realize that buyers are willing to pay more for a larger discretionary earnings flow. For example a business generating a $1M cash flow will almost always generate a higher multiple than a business generating $100,000.

Another popular method of valuation is the Asset approach.  This is more prevalent in industries requiring a lot of equipment and machinery.  This method values the assets and liabilities based on a fair market value and includes any intangible assets and contingent liabilities and the business valuation is derived based on these factors.