Cash Flow, SDE - Determining The Worth Of A Small Business

The value of the small business is mostly determined by the cash flow (or business brokers use the term "Seller's Discretionary Earnings" instead to be more accurate).  Seller's Discretionary Earnings (SDE) is defined as net income before taxes (operating income); interest; depreciation and amortization; owners compensation; owners benefits; and non recurring expenses.

Most small businesses sell for 1.5 - 3.5 (multiples) times the yearly SDE, depending upon the value factors of the business. Things that determine the multiple or value factors are the stability of historical earnings; business & industry growth; type of business (service with few assets to manufacturing with significant assets); location & facilities; stability & skill of employees; competition; diversification of products, service & geographical markets; desirability of the business; depth of management; and terms of the sale. The national average is 2.76 times SDE.

The inventory, equipment or fixtures are included in the price because they are what is required to generate the SDE. Some businesses need inventory, some need equipment (assets) and some need both, depending on the type of business.  The amount of assets is one of the criteria that helps determine the value a business.

Some value (but not too many small business brokers) the business by its  EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization. The multiple that is used is generally in the area of 4 to 6 times EBITDA.  EBITDA is mostly used by investment bankers or M&A folks, people who usually handle bigger stuff ($ 20 million+ price tag).

Business brokers count owner's compensation and owner's benefits as part of earnings or SDE (Seller's Discretionary Earnings).  You can also define SDE as EBITDA plus owner's salary plus owner's benefits.  Basically, if you take SDE times 1.5 to 3.5 multiple, you should have similar numbers if you calculate EBITDA times 4 to 6 times.

The reason business brokers don't usually go by EBITDA times 4 to 6 times is that, it's basically the owner's discretion to pay him/herself salary of whatever the amount and most owners write off a lot of personal expenses through the business (called owner's benefits).

This is one of the worst times to sell a business right now.  No bank financing is available these days so multiples are down, demand is down and a lot of buyers are cash strapped.  I tell sellers if you don't absolutely have to sell, then maybe he/she should hold off.  No one knows when the economy will turn around but it eventually will and once bank starts lending again, multiples of businesses should slowly inch up again.

Below is a list of documents that a typical business broker needs in order to package a business for sale;

1)  last three years of profit & loss statements including balance sheet

2)  last three years of tax returns

3)  copy of the lease

4)  major fixture, furniture & equipment list

These days, selling a business is a tough task.  If your business does sell, it takes an average of 3 - 6 months to find a buyer.  And after negotiating the price, seller and buyer will go through due diligence and then escrow.

There are buyers out there for good, solid businesses - perhaps even more so now, so good luck!

About The Author:  Ron Hottes is with Business Team - a business brokerage team of 28 highly skilled and seasoned professionals within Los Angeles. Our business brokers have over 100 years of cumulative experience and the expertise to help you buy or sell a business in the Los Angeles County area. Ron can be reached at 310-539-8300.

Categories: BizBen Blog Contributor, Business Valuation Issues, How To Sell A Business